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ISBN-13: 978-1-119-40181-0

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Printed in America.

10 9 8 7 6 5 4 3 2 1
 Brief Contents
1 Introduction and Overview of Audit and Assurance   1-1

2 Professionalism and Professional Responsibilities   2-1

3 Risk Assessment Part I: Audit Risk and Audit Strategy   3-1

4 Risk Assessment Part II: Understanding the Client   4-1

5 Audit Evidence   5-1

6 Gaining an Understanding of the Client’s System of Internal

Control  6-1

7 Audit Data Analytics   7-1

8 Risk Response: Performing Tests of Controls   8-1

9 Risk Response: Performing Substantive Procedures   9-1

10 Risk Response: Evaluating Audit Data Analytics and Audit

Sampling for Substantive Tests   10-1

11 Auditing the Revenue Process   11-1

12 Auditing the Purchasing and Payroll Processes   12-1

13 Auditing Various Balance Sheet Accounts (and Related Income

Statement Accounts)   13-1

14 Completing the Audit   14-1

15 Reporting on the Audit   15-1

Appe nd ix A Cloud 9 Inc. Audit A-1

GLOSS ARY    G-1

I n d e x   I -1

v
From the Authors
Auditing is about earning the public trust. Auditors serve that public trust by being indepen-
dent of the companies they audit—in mental attitude and in fact. You will find that auditing
is about developing an inquisitive mind and mastering decision-making; you must master an
audit logic (the audit risk model) and develop audit strategies. To help you develop both skills,
we have taken a very practical approach in this text, as follows:

• P
 rovided a variety of audit reasoning examples, which demonstrate
the practical application of auditing skills and concepts through brief
real-world scenarios, in each chapter.
Auditing is about developing an inquisitive
mind and mastering decision-making. To help • Included an audit decision-making example at the end of each
you develop both skills, we have taken a very chapter. Each example illustrates a process of identifying the issue,
practical approach in this text, as well as incor- gathering information and evidence, analyzing and evaluating infor-
porated audit data analytics (ADA) to help you mation and evidence, and drawing conclusions.
embrace an increasing variety of fascinating • A
 dded professional environment examples that illustrate issues
technologies being used by auditors. that auditors deal with on a day-to-day basis.
• W
 ritten the text in a conversational writing style that you should
enjoy.

In addition, you must also embrace an increasing variety of fascinating technologies being
used by auditors. To help you do this, we have:

• Included a separate chapter on audit data analytics, including an overview of the

most popular audit data analytics (ADA) software applications currently used.
• Integrated the use of audit data analytics into many chapters.
• Offered IDEA-based cases available in WileyPLUS.

The accounting and auditing skills you build in this course will serve you for the rest of your
life as you develop an independence of thought and action. Your journey of developing a
questioning mindset, developing an investigative intuitiveness, and learning how to recognize
accounting issues that do not pass the “smell test” will open many opportunities. If you keep
asking questions, continue to explore the application of new technologies, and stay true to the
importance of integrity and independent thought and actions that will earn the public trust,
you should have a rich and rewarding career.

We are excited and honored to lead you on this “auditing” journey. We hope you dive into the
material and explore the resources provided in this text and WileyPLUS. Above all else, we
wish you great success!

Raymond N. Johnson, PhD, CPA

Laura D. Wiley, PhD, CPA

vi
 About the Authors

©The National Association of State Boards of

©Aaron Hogan, Eye Wander Photo

Accountancy

Raymond N. Johnson Laura D. Wiley

Raymond N. Johnson, PhD, CPA, has taught auditing con- Laura Wiley, PhD, CPA, is the Assistant Department Chair
cepts and practices, financial statement analysis, and a case and senior instructor in the Department of Accounting at
course focused on developing students’ critical thinking skills the E. J. Ourso College of Business, Louisiana State Uni-
at Portland State University for 35 years. He was the first re- versity (LSU). She came to LSU in 1996 and teaches finan-
cipient of Harry C. Visse Excellence in Teaching Fellowship cial accounting and auditing courses. She also leads a study-
and is currently a professor emeritus from Portland State abroad excursion in the Master of Accountancy program,
University. He has also taught auditing and accounting at taking students on educational business trips to Central and
Bond University, The University of Queensland, the Aus- South American countries. Dr. Wiley is active in the Socie-
tralian National University, and Southampton University. ty of Louisiana CPAs (LCPA) and has served as the chair
Dr. Johnson is Chair of the International Accounting of the Accounting Education Issues committee since 2014.
Education Standards Board’s Consultative Advisory Group. She received the LCPA’s Distinguished Achievement in Ed-
Previously, he served on the NASBA board of directors for ucation award in 2015 and the Outstanding Teacher Award
seven years, and he previously chaired NASBA’s Education from the E. J. Ourso College of Business in 1999 and 2014.
Committee and the NASBA Ethics Committee. He also served Dr. Wiley has consulted with large and small companies on
on an AACSB Task Force that was responsible for the most accounting-related matters and conducted onsite training ses-
recent update to AACSB Accounting Accreditation rules. sions for company employees. Over her career, she has also
Dr. Johnson served a three-year term on the AICPA Profession- been a presenter at numerous CPE events and published in
al Ethics Executive Committee which sets ethical standards for the Journal of Accounting Education. Prior to coming to LSU,
CPAs in the United States. He is a former member of NASBA’s she was an auditor with PricewaterhouseCoopers in Atlanta,
Standard Setting Advisory Committee and served for seven Georgia. She earned her bachelor’s degree in accounting from
years on the NASBA/AICPA International Qualifications The University of Alabama, her master’s degree in accounting
Appraisal Board. Previously, Dr. Johnson served on the Oregon from LSU, and her doctorate in human resource education
Board of Accountancy for seven years and was Chair of the and workforce development from LSU. Her research interests
Board for two years. Dr. Johnson is a past president of the Oregon are accounting education and financial literacy. She is an
Society of CPAs. He has previously served as staff to the U.S. active licensed CPA in the state of Louisiana.
Auditing Standards Board, and he has written numerous
academic and professional articles.

vii
Unique Pedagogical Framework
Auditing provides key learning aids to help students master the content and prepare them for
c07AuditDataAnalytics.indd Page 1 06/03/19 3:36 PM F-0590 a successful career in accounting. /208/WB02435/9781119401810/ch07/text_s

ChApter 7 Each chapter begins with a flowchart de-

tailing exactly what section of the audit
process students are about to learn. The
Audit Data Analytics chart helps students see the big picture of
the audit process.
Special thanks to Dr. Adrian Gepp of Bond University, Queensland, Australia, for his invaluable
assistance in co-authoring this chapter.

The Audit Process

Overview of Audit and Assurance

(Chapter 1)

Professionalism and Professional Responsibilities

(Chapter 2)

Client Acceptance/Continuance and Risk Assessment

(Chapters 3 and 4)

Gaining an Identify Significant

Set Planning
Understanding of Accounts and
Materiality
the Client Transactions

Gaining an Understanding
Make Preliminary Risk
of the System of Internal Control
Assessments
(Chapter 6)

Develop Responses to Risk and an Audit Strategy

Audit Data Analytics
Audit Evidence
(Chapter 5)

(Chapter 7)

Performing Tests of Controls Performing Substantive Procedures

(Chapter 8) (Chapter 9)

Audit Sampling for Substantive Tests

(Chapter 10)

Auditing the Auditing the Purchasing Auditing the Balance Sheet

c03RiskAssessmentPartI.indd Page 3-2 24/01/19 9:35 PM F-0590 /208/WB02435/9781119401810/ch03/text_s
Revenue Process and Payroll Processes and Related Income Accounts
(Chapter 11) (Chapter 12) (Chapter 13)

Completing and Reporting on the Audit

(Chapters 14 and 15) 3-2 CH A PT E R 3 Risk Assessment Part I

Procedures Performed Near

the End of the Audit
c05AuditEvidence.indd Page 2 04/03/19 8:37 PM F-0590
Drawing Audit
Conclusions
Reporting
/208/WB02435/9781119401810/ch05/text_s
LearningLearning
Objectives Objectives have been carefully craft-
ed to reflect the Bloom’s
LO 1 Evaluate client acceptance and continuance Taxonomy
LO 5 Explain framework,
how auditors determine their audit
decisions. strategy and how audit strategy affects audit decisions.
5-2 Chapt e r 5 audit evidence LO 2 Identifyas well
the diff asofreinforce
erent phases an audit. the practical
LO 6 Explain auditing
the fraud risk assessment skills
process and

that students will develop.

analyze fraud risk.
LO 3 Explain and apply the concept of materiality.
Learning Objectives 7-1 LO 4 Explain professional skepticism and apply the
audit risk model.
LO 1 Define management assertions about classes of LO 4 evaluate when it is appropriate for auditors to use
transactions, account balances, and presentation and the work of others.
disclosure. LO 5 Document the details of evidence gathered in Auditing and Assurance Standards
LO 2 Discuss the characteristics of audit evidence. working papers.
LO 3 apply the procedures for gathering audit evidence,
P C AO B AUDIT ING STA NDA R D S B OA R D
including the use of audit data analytics.
AS 1015 Due Professional Care in the Performance of Work AU-C 200 Overall Objectives of the Independent
Auditor and the Conduct of an Audit in Accordance With
AS 1101 Audit Risk
Generally Accepted Auditing Standards
AS 1301 Communications with Audit Committees
Auditing and Assurance Standards AS 2101 Audit Planning
AU-C 210 Terms of Engagement
AU-C 240 Consideration of Fraud in a Financial
AS 2105 Consideration of Materiality in Planning and Statement Audit
PCAOB
Auditing and Assurance
AS 1105 audit evidence Standards
audit Documentation that are dis-
Au d i t i n g StA n dA rd S B OArd
Au-C 230
Performing an Audit
AU-C 300 Planning an Audit
AS 2110 Identifying and Assessing Risk of Material
cussed are listed
AS 1205 part of the audit performed by Other
Independent auditors
at the beginning the risks of of each chapter
Au-C 315 Understanding the entity and Its environment
and assessing Material Misstatement
Misstatement
AU-C 315 Understanding the Entity and Its Environment
and Assessing the Risks of Material Misstatement
AS 2301 The Auditor’s Responses to the Risks of
AS 1210 for
Using thequick reference. AAu-C
Work of a Specialist complete
500 audit evidence
overview of all Material Misstatement
AU-C 320 Materiality in Planning and Performing an
Au-C 505 external Confirmations Audit
AS 1215 audit Documentation
AS 2110 standards isrisksavailable at
Au-Cthe front of the text.
AS 2401 Consideration of Fraud in a Financial
600 Special Considerations—audits of Group AU-C 330 Performing Audit Procedures in Response to
Identifying and assessing of Material Statement Audit
Financial Statements (Including the Work of Component Assessed Risks and Evaluating Audit Evidence Obtained
Misstatementc03RiskAssessmentPartI.indd Page 3-40 24/01/19 9:35 PMauditors)
F-0590 /208/WB02435/9781119401810/ch03/text_s AS 2610 Initial Audits—Communication Between
QC10 A Firm’s System of Quality Control
AS 2310 the Confirmation process Predecessor and Successor Auditors
Au-C 610 Using the Work of Internal auditors
AS 2605 Consideration of the Internal audit Function Au-C 620 Using the Work of an auditor’s Specialist

3-40 C HAPT E R 3 Risk Assessment Part I

Cloud 9 - Continuing Case
Sharon and Josh have already discussed some specific client accep- and is part of professional ethics. Sharon also gives Josh the task
Cloud 9 - Continuing
Cloud 9 - Continuing Case
Case Page 5-6
c05AuditEvidence.indd 1/15/19 9:44 PM f-1241 /208/WB02435/9781119401810/ch05/text_s
A Cloud 9 Continuing Case exercise
tance issues, such as independence threats and safeguards. Sharon
explains they also must consider the overall integrity of the client
of researching Cloud 9’s press coverage, with special focus on any-
thing that may indicate poor management integrity.

applies concepts introduced in each

W&S Partners has just won the January 31, 2023, audit for W&S Partners use the following percentages as starting (that is, management of Cloud 9). This means they need to perform Sharon emphasizes they must perform and document proce-
At the next planning meeting for the
Cloud Cloud
9. The 9 audit,
audit teamSuzie Pickering
assigned handle
to this client is: the accounts receivable pointsandforinventory
the variousthemselves.
bases: Second, and document procedures that are likely to provide information dures to determine whether W&S Partners is competent to per-
presents the results of the analytical procedures performed so far Sharon is worried about how they will gather evidence regarding a about the client’s integrity. Josh is a little skeptical. “Do you mean form the engagement and has the capabilities, time, and resources

chapter, concludes each chapter, and is

and a working draft of the audit program. The audit manager, subsidiary of Cloud 9 located in Vietnam.Base W&S Partners does Threshold (%)
not that we should ask them if they are honest?” Sharon suggests it is to do so. For example, they must make sure they have audit team
• Partner, Jo Wadley
Sharon Gallagher, and the audit senior, Josh Thomas, are5-6 C H APT
also in- E R an
have 5 office
AuditinEvidence
Vietnam, so they mustIncome determine before
the tax
most effec- 5.0 probably more useful to ask others, and the key people to ask are members who understand the clothing and footwear business.
• Audit Manager, Sharon Gallagher
volved in the planning, with special responsibility for the internal Total revenue
tive and efficient way to gather evidence regarding the subsidiary. 0.5 the existing auditors. Josh is still skeptical. “The existing auditors They also must have enough staff to complete the audit on time.
control assessment. • Audit Senior, Josh Thomas
The meeting’s agenda is to• discuss
IT AudittheManager,
availableMark
sources of ev-
Batten
In the planning meeting,
questions:
• the
An team Gross
auditor
down ifTotal
profites
considers
verifi
it isassets
Equity
thethat
following
equipment 2.0 used in operations has been appropriately
0.5
impaired (risk of overstatement).
1.0
marked
are Ellis
available as an assessment question.
& Associates. Are they going to help us take one of their
clients from them?” Sharon says the client must give permission
In addition, Sharon and Josh must perform and document
procedures to show that W&S Partners can comply with all parts
idence at Cloud 9 and specify these in the detailed audit program. first, and, if that is given, the existing auditor will usually state of the code of professional conduct, not just those that focus on
• Experienced staff, Suzie Pickering • What evidence is available?
The team members also must ensure they have enough evidence whether or not there were any issues that the new auditor should independence threats and safeguards. Finally, they can draft the
• First-year These starting points
• What criteria will the team use to choose among alternative can be increased or decreased by taking
to conduct the audit. Two specific issues staff
worry, Ian Harper of the
members be aware of before accepting the work. This type of communica- engagement letter to cover the contractual relationship between
team. First, there are three very large asset balances on Cloud Cloud
9’s 9 - sources
Continuingof evidence? Case
into account qualitative client factors, which could be:
tion is covered by AS 2610 (AU-C 210 for private company clients) W&S Partners and Cloud 9.
trial balance that have particularAsvaluation
a part of the risk Josh
issues. assessment
suggestsphase for•the Whatnewareaudit,
the the
implications • The naturethe
of using of the
workclient’s business and industry (for example,
of specialists
audit team needs to gain an Ian and Suzie have9’salready talked in general terms about the • No accounts receivables were omitted when calculating the
that a specialist will be required for the derivatives, butunderstanding
they can of Cloud
and other structure
auditors? rapidly changing, either through growth or downsizing, or
and its business environment, determine errors that could occur
materiality, in Cloud 9’s accounts receivable. For
and assess total—completeness.
an unstable environment).
the risk of material misstatement.example,
This will basic
assist mathematical
the team in de-mistakes• and other clerical errors
Whether the client is a public •company
Accounts(orreceivables
subsidiaryincluded
of) in the total do exist at year-
veloping an audit strategy and designingcould afftheectnature,
the customer’s total in either
extent, and direction. Suzie em- end—existence.
phasizes that Cloud 9’s management asserts subjectthis
to regulations.
error did not
timing of audit procedures.
exist when they prepared the fi •
nancial The knowledge
statements—i.e., of or high
they risk of• fraud.
Accounts receivables belong to Cloud 9 and have not been
One task during the planning phase is to consider the con-
Chapter Preview—Audit Process in Focus
cept of materiality as it applies to assert that accounts
the client. Auditorsreceivable
will de- areTypically,
valued correctly. Auditors sold or factored—rights and obligations.
income before tax is used; however, it cannot be used
sign procedures to identify and correct must gather
errorsevidence about each assertion for each transaction
or irregularities • Bad debts have been provided for—valuation and allocation.
if reporting a loss for the year or if profi tability is not consistent.
In Chapters 3 and 4, we
that would have a material effect
considered
class, account,
on the
audit riskinand
and statements
financial note the risk assessment.
financial statements.Those Now chapters
that focused
When calculating PM based on interim • Salesfifrom
gures,the
it may
nextbeperiod
nec- are not included in the earlier
and affecton the
the decision-making
importance of risk Ian identification
understands
of the users of this thetofinancial
helpbetter,
idea ensure he the auditor’sthe
can identify desired level of risk is the auditors to plan
assertions
essary to annualize the results. This allows period—cutoff. Ian is a bit confused about this because cut-
statements. Materiality is used inthat relate to audit
determining the potential
procedures errors in accounts receivable that
the audit properly based on an approximate off is anprojected
assertionyear-end
for transactions, not assets. Suzie agrees
and sample selections, and evaluating they discussed
differences earlier:
from client balance. Then, at year-end, the figure isitadjusted, if necessary,
is a special to
sort of assertion that relates to transactions or
records to audit results. Materiality •is No the mathematical
maximum amount of or other
mistakes reflectclerical
the actual results.
errors exist that events, but also gives evidence about balance sheet accounts
misstatement, individually or in aggregate, couldthat canthe
affect betotal
accepted
receivables in either direction—valua- (e.g., an overstatement of revenue is also an overstatement
in the financial statements. In selecting Required
tion the
andbase figure to be
allocation. of receivables).
used to calculate materiality, the auditors should consider the Answer the following questions based on the information pre-
key drivers of the business. They should ask, “What are the end sented for Cloud 9 in the appendix to this text and in the current
users (that is, stockholders, banks, etc.) of the accounts going chapter and previous chapters.
viii to be looking at?” For example, will stockholders be interested
in profit figures that can be used to pay dividends and increase
The last category of assertions focuses on presentation and disclosure in the financial
statements
a. Using the andOctober
the notes. You’ve
31, 2022, trialprobably
balance (innoticed that most
the appendix to of the assertions in this category
this listed
are also text), calculate
in one or planning
both of materiality
the other and include theThat
categories. justi-makes sense considering the note
share price?
fication and
disclosures for the basis that youin
presentation have
theused for yourstatements
financial calculation. are inherently tied with a client’s
W&S Partners’ audit methodology dictates that one plan-
ning materiality (PM) amount is to be used for the financial transactions
b. Discuss how andthe year-end
planningbalances.
materiality Auditors
would begather
used toevidence
deter- that disclosed items represent
statements as a whole. The basis selected for determining events mineandperformance
transactions materiality.
that occurred and pertain to the entity, (10) occurrence and rights
materiality is the one determined to be the key driver of the and obligations,
c. If the planningand that allamount
materiality itemsisthat should increased
subsequently have been or disclosed are included in the fi-
business. nancial statements,
decreased later in which is how
the audit, (11) would
completeness. Auditors
that impact ensure items included in the finan-
the audit?
cial statements are appropriately presented and disclosures are clearly expressed, which is
 controls continue to be strong, she will also perform substantive procedures on the existence of
inventory at an interim date.

Illustration 3.12 provides a diagram of the process used when developing the audit strat-
egy for an account or assertion. Notice that the left side of the diagram provides an overview
  UN I Q UE P E DAG OG I C A L FRA MEWORK ix
of the reliance on controls approach described in this section.

c05AuditEvidence.indd Page 5-27 1/15/19 9:44 PM f-1241 /208/WB02435/9781119401810/ch05/text_s

ILLUSTRATION
4 04/03/19 3.12
Detailed illustrations help students visualize
c06GainingAnUnderstandingOfTheClientsSystemOfInternalControl.indd Page 5:48 PM F-0590 /208/WB02435/9781119401810/ch06/text_s
Identify inherent risks at the account or assertion level Process used when developing
an audit strategy at the

complex processes and important concepts.

account or assertion level
Documentation—Audit Working Papers 5-27
Determine whether an6-4
internal control(s)
C h apt e r 6 canGaining an Understanding of the Client’s System of Internal Control
mitigate the risk factor
alternative for environmentally conscientious customers. NME operates from three locations
and produces a wide range of household products that it sells to supermarkets and specialty
the COSO Frameworkstores.
YES NO The COSO framework has global acceptance and At the most
is the front commonly
of every audit file is a copy
recognized frame- of the client’s trial balance that supports the fi-
work for understanding and evaluating a system nancial statements.
of internal TheIttrial
control. balance
has three is then referenced into the appropriate lead and support-
dimensions,
as shown in Illustration 6.1. First, the COSO ing schedules
framework in the audit
discusses file whereofaudit
the objectives work is documented for each account in the trial
internal
balance. At Bell & Bowerman,
control. Second, the COSO framework discusses important components of internal control. LLP, the trial balance is referenced using the letter “A”; cash
Does the control(s)
NOF-0590
c03RiskAssessmentPartI.indd Page 3-15 24/01/19 9:35 PM Third, the COSO framework discusses how these andobjectives
cash equivalents in variousfit
and components
/208/WB02435/9781119401810/ch03/text_s
banks
into are referenced into the C Lead; accounts receivable are
an orga-
exist? referenced into the E Lead; inventory accounts are referenced into the F Lead; property, plant
nizational structure.
Reliance on Controls Approach

and equipment are referenced into the K Lead; and so on.

The first working paper example is the cash and cash equivalents lead schedule

Substantive Approach
iLLuStrAtiOn 6.1 Objectives
(see Illustration 5.8). The purpose of this lead is to summarize all general ledger accounts
YES

Organizational structure
The relationship among the that are combined into the cash and cash equivalents account on the financial statements.

ce
s
Professional Skepticism and Audit Risk 3-15

ng

n
three dimensions of internal

io

ia
The lead schedule also has adjusting journal entries, if any, that are proposed by the auditor.

rti
at

pl
po
er
control: objectives, components,

m
In the top-left corner of the lead schedule are the client name, period-end, and currency

Op

Co
Re
and organizational structure
Professional Skepticism unit (in this example, balances are rounded to the nearest thousand dollars). In the top

Function
Test the

Operating unit
Control environment
control(s) center of the lead schedule is section identification (C). In the top-right corner, details of
Auditors have a responsibility to plan and perform an audit with professional skepticism. the working paper preparer and reviewers are documented. Next, details of the cash and

Division
Components
Risk assessment
Professional skepticism is an attitude adopted by auditors when conducting all phases of the cash equivalents balance are listed. For each item listed in the lead schedule, the following

Entity
audit. It means that auditors remain independentIncrease
of the extent
entity,ofitsdetailed
management, and its staff are noted:
Control activities
Is the control(s)
when completing the audit work.NO In a practical sense, professional skepticism means au- professional skepticism an
substantive procedures
effective? Does it work?
ditors maintain a questioning mind and thoroughly investigate
performed all evidence presented by the Information
at year-end attitude that
andincludes a• question-
communication General ledger account number, per the client records.
client (AS 1015.07). For example, AU-C 200.A22 states auditors should be skeptical if any of ing mind, being alert to condi-
the following arise during the audit: tionsMonitoring indicate• possible
that may activities General ledger account name, per the client records.
misstatement due to fraud or
• Preadjusted balance, any adjustments, and the audit-adjusted current-year balance per
YES error, and a critical assessment of
• Audit evidence recently gathered that is contradictory to other evidence previously gathered. the client’s trial balance (TB).
audit evidence
• New information that brings into question the reliability of clientObjectives of Internal Control
documents or responses • The prior-year balance, per the prior-year audit file (PY).
to auditor inquiries.
Perform less extensive The COSO framework depicted in Illustration 6.1 identifies three objectives of internal control
• Conditions
detailed substantivethat may provide evidence of possible fraud.
that allow organizations to focus on the differing purposes of internal control. These three
Many illustrations, such as work- procedures at interim
• Situations that indicate the need for additional audit procedures objectives
by generally accepted auditing standards.
beyond what are:is required ILLUSTRATION 5.8 Working paper example: Cash lead schedule

ing papers and confirmations,

• Operations objectives. These pertain to the Client:
effectiveness and efficiency
New Millennium of the entity’s op-
Ecoproducts Bell & Bowerman, LLP Prepared by: KM 1/21/2023
Does maintaining professional skepticism mean auditors should assume clientincluding
erations, manage-operational and financial performance
Period-end: goals, and safeguarding assetsC–LEAD
12/31/2022 Reviewed by: SO 1/22/2023
ment is being dishonest? The answer is no. Auditors should not assume management
against loss. is dis- Currency unit: $000 Reference: C-Lead Reviewed by: MM 1/24/2023

present documents that students

honest, but at the same time, auditors should not assume management
correct. Using professional skepticism means that even if auditors believe
is always honest
• Reporting
management
reporting and may
or These pertain to internal and external financial and nonfinancial
objectives.
andencompass reliability, timeliness,
Lead schedule:
transparency, or other terms as set
those charged with governance are being honest, they should gather reliable evidence to sup- recognized standard setters, or the entity’s policies.
will encounter in a real-world
forth by regulators, Pre- Adjusted
port management’s responses to auditor inquiries and to support amounts and disclosures
• Compliance objectives. These pertain to adherence to laws and regulations to which adjusted the current-year Prior-year
in the
c03RiskAssessmentPartI.indd financial
Page statements.
3-28 24/01/19 9:35 PMThroughout
F-0590 all phases of the audit, auditors should keep these /208/WB02435/9781119401810/ch03/text_s
Account balance balance balance %

audit.
entity is subject.
questions in mind when gathering audit evidence: Is this information reliable? Do we need to no. Account name 12/31/2022 Adjustments 12/31/2022 12/31/2021 Variance Variance Ref
perform more audit procedures? When auditors exercise professional skepticism during the (COSO, Internal
10100 Control—Integrated Framework,
Cash in Bank: Wells Fargo 2013)
$ 11,000 $0 $ 11,000 TB $ 10,500 PY $500 5% C01
risk assessment phase, it helps to ensure they are using appropriate assumptions when devel-
10200 Cash in Bank: U.S. Bank 134 0 134 TB 134 PY 0 0% C02
oping their audit strategy that will be used in the risk response phase.These
In thethree
reporting phase,of internal control help the
objectives auditor understand why the controls are
3-28 CHAPTE auditors
R 3 Riskuse Assessment
professional skepticism
Part I when evaluating the evidence gathered
important and forming
and an
the problems they are designed 10300
to prevent.
CashWithout understanding the
in Bank: Barclays 126in- 0 126 TB 126 PY 0 0% C03
opinion that the financial statements are presented fairly. tention of management in implementing internal controls,
10400 CashitinisBank:
harder to understand 56
Citigroup how 0 56 TB 50 PY 6 12% C04
• Ongoing losses. controls prevent, or detect and correct, financial statement misstatements. Management
10500 Short-Term Deposits 5,796 0 5,796 TB 5,600 PY 196 4% C05
and those charged with governance are concerned about adequately controlling the entity’s
• Rapid growth.
Audit Reasoning Examples apply chapter
operations, its financial reporting, and its compliance with laws
Total and
Cash andregulations.
Cash The exter-
$17,112 $0 $17,112 $16,410 $702 4%
Audit Reasoning• Example Poor cash flowsProfessional
combined withSkepticism
high earnings.
nal auditor, on the other hand, is primarily concerned withEquivalentsthe reporting objectives and the
• Pressure to meet market expectations and operations objectives related to safeguarding ofKey
profit targets. assets.
to audit tick marks (TM):
An auditor was auditing• aPlanning
recreational vehicle
to list on a(RV) dealership.
stock exchange. The auditor had obtained some
initial financial information from the client showing unaudited results for
• Planning to raise debt or renegotiate a loan.
the end of the third
Components of Internal Control
TB Agrees to client’s trial balance.
PY Agrees to prior-year audit file. concepts in brief real-world scenarios that
students might encounter in a professional
quarter. Sales were up and profit margins were up, making it the best year so far for the client. Background: No significant changes in banks or bank accounts from the prior period. Note: Analytical review on movements in the cash flows has
Interim records showed •that The client being
inventory was alsoabout to enter
up, and into ainventory
the client’s signifi
Thecant newshowed
second
records contract.
dimension
over of the COSO framework depicted
been performedin on
Illustration
the cash flow6.1 identifies
schedule — seefive
A1.1.
300 RVs on hand at the •end A of the third
signifi quarter. Theofaudit
cant proportion remuneration tointegrated
senior wenttied talk to the components
to earnings audit man-
(that of internal
is, bonuses control:
or stock options).
ager about the good news and the client’s performance. The audit manager asked the senior a key
question. “You did the inventory observation last year. How many RVs did the • Control
client haveenvironment.
then?” environment. They also provide real-world
Comments: Cash and cash equivalents: In line with budget and change consistent with level of activity for the period (see also our review of the
statement of cash flows referenced in A1.1). Short-term deposits: Although the balance is very consistent with previous period, inclusion of
short-term deposits within cash and cash equivalents is acceptable (refer to C5).
“I think it was about 210,” the senior replied. Then the audit manager asked, “How • Riskfull was the lot

company examples of chapter concepts.

assessment.
last year?” The senior replied that it was “almost overflowing” the year before. The manager then
• Control activities.
Audit
said, “Let’s look at this more Reasoning
skeptically. Example
I don’t think they have storage
Fraud capacity for another
at Toshiba: Part90 I
RVs even though sales are up. There could be an error in the inventory records. This information
makes me believe that the existence of inventory is a very high inherent risk.”
You may be familiar with Toshiba Corporation, a publicly traded Japanese company headquar-
tered in Tokyo that makes consumer electronics, household electronics, office equipment, and
more. In July 2015, the CEO of Toshiba announced he was resigning amid an accounting scandal
in which profits had been overstated for the past seven years by approximately $1.9 billion (224.8
Audit Risk billion yen). What incentives and pressures were involved that led to the fraud? The technology
industry is extremely competitive and Toshiba’s upper management set aggressive profit targets.
Audit risk is the risk that The home electronics and appliances division was showing losses and the memory chip division
an auditor expresses an inappropriate audit opinion when financial
was feeling pressure because of decreasing demand from Chinese electronics companies.6 As an
statements are materially misstated (AU-C 200 Overall Objectives of the Independent Auditor
example, in September 2012, the head of the digital products and service division was told by the
and the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards and
CEO to improve a 24.8 billion yen loss into a 12 billion yen profit in just three days!7 Think about
AS 1101 Audit Risk). Thishow meansthe the audit
external reportwould
auditor stateslearn
the about
financial statements
the incentives aretopresented
given lower-level management. How
fairly, in all material respects,
might when in actuality
an internal the fiabout
auditor learn nancial
thesestatements
incentives?contain a material
error or fraud. While it is impossible to eliminate audit risk, auditors aim to reduce it to an c05AuditEvidence.indd Page 5-20 1/15/19 9:44 PM f-1241 /208/WB02435/9781119401810/ch05/text_s

Opportunities to Perpetrate a Fraud 5-20 CH A PT E R 5 Audit Evidence

After identifying one or more incentives or pressures to commit a fraud, auditors assess

Professional Environment boxes

whether a client’s employees have an opportunity to perpetrate a fraud. Auditors utilize their
knowledge of how other frauds have been perpetrated to assess whether the same opportuni-
Professional Environment Working with IT Auditors
ties exist at the client. While the examples below of opportunities to commit a fraud suggest
provide in-depth discussions of
a fraud may have been committed, their existence does not mean a fraud has definitely oc-
curred. Auditors must use professional judgment to assess each opportunity in the context of
Specialist IT auditors are often used in audits of clients with com-
plex information technology (IT) environments because the effec-
Finally, Brazel argues that the research findings demon-
strated that auditors need to consider the implications of finding
tive audit of the IT systems contributes to overall audit quality. a balance between greater software-assisted audit techniques

how concepts in a chapter are ap-

other risk indicators and consider available evidence thoroughly.
Examples of opportunities that increase the risk that a fraud may have been perpetrated
Large audit firms usually have such specialists within the firm, but
smaller audit firms could engage external IT consultants for this
training for financial statement auditors and greater use of IT
specialists for overall audit efficiency and effectiveness.
include:
plied in the business world.
part of the financial statement audit. In general, reliance on an The role of IT audit specialists could grow to become even
IT specialist is appropriate when the financial statement auditor more than a support function for auditors. Some researchers
• Accounts that rely on estimates and judgment (discussed further in Chapter 9). complies with the conditions of AU-C 620. suggest that in e-businesses, the external financial statement
c03RiskAssessmentPartI.indd Page 3-32 24/01/19• 9:35
A high volume of
PM F-0590 transactions close to year-end. /208/WB02435/9781119401810/ch03/text_s If the IT expert and the financial statement auditor do not auditor’s authority will be challenged by IT audit specialists be-
work well together, audit quality can be impaired. For this rea- cause of technological change and its impact on auditing.13 In
• Significant adjusting entries and reversals after year-end.
son, researchers have investigated the factors that affect the way e-businesses, economic transactions are captured, measured,
• Significant related-party transactions (discussed further in Chapter 4). that financial statement auditors work with specialist IT auditors. and reported on a real-time basis without either internal human
• Poor corporate governance mechanisms. Brazel12 reviewed this research evidence and drew the following intervention or paper documentation.14 Auditing is likely to be-
conclusions. First, responses from financial statement auditors in come more real-time and continuous to reflect the pattern of the
3-32 CHAPT E R 3 • Poor
Risk Assessment Part system
I of internal control (discussed further in Chapters 6 and 8).
the United States who were surveyed about their experiences with transactions. If traditional auditors are unwilling or unable to
• A high turnover of staff with accounting or internal control responsibilities. IT auditors indicated that they believe IT auditors’ competence adapt to the new environment, their role could be taken over by
levels vary in practice. Financial statement auditors also said that IT specialists.
Audit Decision-Making Example IT auditors appear to be overconfident in their abilities in some Other developments such as reporting using XBRL (eXten-
settings, and questioned the value provided by IT auditors to the sible Business Reporting Language) provide challenges for au-
6
E. Pfanner and M. Fujikawa, M. “Toshiba Slashes Earnings for be
Past Seven Years,”locations
The Walldue
Street financial statement audit. ditors as they have to adapt their techniques and approaches to
Background Information • Fraud risk may high in some to Journal,
the opportu-
September 7, 2015. https://www.wsj.com/articles/toshiba-slashes-earnings-for-past-7-years-1441589473 Second, Brazel suggests the research shows that both finan- audit financial information that is disaggregated and tagged. Us-
You have been assigned to the7 audit of inventory for a private nity offered by weak internal controls.
K. Nagata. “Pressure to show a profit led to Toshiba’s accounting scandal,” The Japan Times, September 18, cial statement auditors’ IT ability and experience and the IT audi- ers can extract and analyze XBRL data directly without re-entry
company that owns and operates a chain
2015. of retail jewelers. The • The auditor needs to determine how internal controls afft-ect
http://www.japantimes.co.jp/news/2015/09/18/business/corporate-business/pressure-to-show-a-profi tor’s competence affect how these two professions interact on an and the tag provides additional information about the calculation
company’s sales revenue has grown by 300% in the last two years,
led-to-toshibas-accounting-scandal/#.WNJjNmQrLjAaudit strategy, and whether the auditor wants one audit strat- audit engagement. This indicates that audit firms need to ensure and source of the data. This means auditors have to recognize that
primarily by acquisitions. Seventy-eight percent of the value of the egy for part of the inventory and another audit strategy for that staff training and scheduling produce appropriate combi- their clients are reporting financial data with different levels of
company’s inventory is in wedding rings, diamonds, gold neck- another part of the inventory. nations of financial statement auditors and IT auditors on an information and users might have greater expectations of the data.
laces, and high-end watches. Because the company has grown engagement. Learn more about XBRL at www.xbrl.org.
through acquisition, the company has not yet brought two ac- Analysis and Evaluation of Alternatives
quired companies (representing 35% of sales) under the company’s Analysis of risk:
inventory system. As a result, the company is currently operating
• Inherent risk factors include valuable inventory that is sub-
with three different inventory-control systems. The core inventory
ject to theft and misappropriation.
system being used by retail stores represents 65% of sales. Sixty
• Internal controls are not uniform. Based on prior year’s evi-
percent of inventory was tested in the prior year and controls over Cloud 9 - Continuing Case
the existence of inventory were effective. dence and a preliminary understanding of the system in the
The CFO’s top priority is to put all retail operations under this current year, strong internal controls appear to operate over Josh will take responsibility for obtaining a specialist’s opinion on has some experience of using a derivatives specialist on prior audits,
one inventory-control system by the end of the fiscal year (Janu- only 60% of the inventory. the derivatives. He knows that W&S Partners has other staff (who and he also plans to ask Jo Wadley (the partner) to recommend a
ary 31). He is particularly concerned about lower than expected • It may be more efficient to physically inspect inventory as of are not part of the audit team) who can provide additional expertise. suitable specialist.
gross margins at some of the acquired stores, and he expects that one date and use one audit strategy for all inventory testing. However, because he believes the accounts are so material to the Josh plans to investigate any possible connections between
better inventory control will improve this situation. In addition, audit and derivatives have become such a big issue in audits in recent the specialist and Cloud 9 that could adversely impact the special-
• Fraud risk is considered to be high at locations where inven-
gold prices have risen 15% in the last 12 months, and the company years, he deems an external specialist’s opinion is also required. He ist’s objectivity before engaging him for this audit.
tory controls are not strong.
is making sure it is not selling “conflict diamonds” illegally traded
to fund conflict in war-torn areas of Africa. Your responsibility is
Conclusions Regarding Audit Strategy for the Existence
to develop an audit strategy for testing the existence of inventory.
of Inventory

Each chapter concludes Usingwiththean

Work of Internal Auditors
Audit
Identify the Audit Issue • Inherent risk is set at the maximum because inventory is
The focus of attention in this instance is to develop an audit strat- high in value and susceptible to theft and misappropriation.
egy for testing the existence of inventory. The auditor may develop • Control risk is set at high, as 40% of inventory may not have internal auditors employees The role of the internal audit function was introduced in Chapter 1. Internal auditors are
a different audit strategy for testing the valuation of that inventory.

Gather Information and Evidence

sufficient internal controls.
• Fraud risk is considered high due to the opportunity offered
Decision-Making Example that takes students of the client who perform assur-
ance and consulting activities
employees of the client who perform assurance and consulting activities designed to evaluate
and improve the effectiveness of the entity’s governance, risk management, and internal con-

through specific steps of the audit process

by weak internal controls. designed to evaluate and improve trol processes. Not every client will have an internal audit function. For example, small and
Important information includes: the effectiveness of the entity’s
• This results in setting detection risk at low. medium-sized companies, especially private companies, may not have the resources to staff
• A significant portion of the inventory is high in value, small governance, risk management,
an internal audit function. But if the client does have an internal audit function, what role,
while offering solutions to issues presented
• Low detection risk impacts the nature, timing, and extent of and internal control processes
in size, and susceptible to theft. if any, do the internal auditors play in the financial statement audit? According to AU-C 610
substantive testing. For example, the auditor will plan test-
• A good system of internal controls may not be operating ing of the physical existence of inventory at year-end, select

throughout the example.

effectively and uniformly. a larger number of locations to visit, and vary the extent of
12
• The weak gross margins in some stores may be evidence of inventory testing at each location depending on internal con- J. F. Brazel. “How do financial statement auditors and IT auditors work together?” The CPA Journal,
inventory shrinkage or theft. trols over the counting of inventory at each location. November, 2008, pages 38–41.
13
A. Kotb, C. Roberts, & S. Sian. “E-business Audit: Advisory Jurisdiction or Occupational Invasion?” Critical
Perspectives on Accounting 23, no. 6 (2012), pages 468–82.
14
Kotb et al., 2012.

CPAexcel
CPAexcel questions and other resources are available in WileyPLUS.
Engaging Students with WileyPLUS
Auditing is completely integrated with WileyPLUS, featuring a suite of teaching and learning
resources developed under the close review of the authors. Driven by the same basic beliefs
as the text, WileyPLUS allows students to practice their understanding of concepts and access
the content and resources needed to master the material. Features of the WileyPLUS course
include the following:

Student Practice
Each chapter includes practice questions
for each learning objective that students
can review to assess their understanding
of chapter topics.

Tableau Homework
Assignments
Tableau visualizations accompa-
nied by questions are available
with most chapters. Tableau vi-
sualizations allow students to in-
terpret visualizations and think
critically about data.

IDEA Cases
Select chapters include IDEA cases that allow stu-
dents to use IDEA software to analyze data. An IDEA
casebook and accompanying data sets, provided by
Audimation Data Analytic Software and Services, is
also available.

Real-World Videos
 loomberg videos accompany each chapter,
B
providing students with relevant examples of
auditing practices in the professional world.

x
    ENGAGING STUDENTS WITH WILEYPLUS xi

Relevant Accounting
Articles
Up-to-date accounting articles are post-
ed to the Wiley accounting update site,
www.wileyaccountingupdates.com.
Many of these news updates direct
students to news-related videos and
articles that address auditing-related
topics.

Adaptive Practice
Adaptive practice is a tool students can use to
understand the essentials of auditing. Students
can answer a multiple-choice question and,
based on their response, the adaptive practice
software will recommend another question
to help students assess their understanding
of a topic. Detailed reports also help students
identify where they need to focus their studies.
There are hundreds of adaptive questions for
students to answer in the Auditing course.
Preparing for the CPA Exam
For each chapter in the WileyPLUS course, students can access CPAexcel videos, CPA Exam
Practice Questions in the PrometricTM Testing Interface, and Task-Based Simulations (TBSs),
which are the primary form of assessment used by the American Institute of Certified Public
Accountants (AICPA). These resources:

1. Reinforce understanding of course topics.

2. Demonstrate relevance to show students how the auditing content they are learning will be
assessed on the CPA exam.
3. Build student confidence with early exposure to CPA exam questions.

CPA Exam Practice Questions in

the Prometric™ Testing Interface
Wiley partners with CPAexcel to provide pre-created
CPA exam practice questions for each chapter that
recreate the environment students will encounter on
the CPA exam.

Task-Based Simulation in the

Prometric™ Testing Interface
CPA simulations recreate the simulation envi-
ronment students will see on the CPA exam.
Similar to the CPAexcel multiple-choice home-
work questions, instructors can assign a simu-
lation as a gradable assignment.

CPA Exam Video Lessons

Each chapter includes CPA exam text discus-
sions and videos that provide students with
insight into auditing topics commonly ad-
dressed on the CPA exams.

CPA Exam Assignment

Each chapter includes one pre-created CPA
exam assignment that allows instructors to
assign multiple-choice questions adapted
from prior CPA exams. Student performance
is tied to the WileyPLUS gradebook.

xii
 Student Assessment
Each chapter of Auditing in WileyPLUS has over 300 assessment questions that can help keep
your students engaged and on track.

End-of-Chapter Assessment
Questions and Problems
Each Auditing text chapter concludes with over 40 gradable assessment questions and problems
you can use to gauge students’ understanding and ability to apply auditing concepts, as follows:

• M
 ultiple-Choice Questions—Available to quickly and effectively test students’ under-
standing of the chapter material.
• S
 hort Answer Questions—Open-ended questions that require students to begin
thinking critically about the auditing process.
• A
 nalysis Problems—Designed after scenarios students might encounter as auditors in
the business world, analysis problems assess how well students understand specific topics
in a chapter.

Cases
Because no two audits are alike, Auditing uses a practical, case-based approach to help stu-
dents develop professional judgment, think critically about the auditing process, and develop
the decision-making skills necessary to perform a real-world audit. The best way for a student
to learn auditing is to actually do auditing. To help provide real-world application, we have
developed the following cases:

• A
 udit Decision Cases—Three cases run through most of the text chapters and provide
a broad review of the audit process (King Companies, Inc., Mobile Security, Inc., and
Brookwood Pines Hospital). In addition, chapter-specific cases help you assess students’
understanding of topics that are the focus of a particular chapter.
• C
 loud 9 Continuing Case—Requires students to apply chapter concepts to the ongoing
Cloud 9 case that is highlighted in the chapter.

To help you more easily identify what questions you want to assign, questions are tagged
with learning objectives, professional AICPA and AACSB outcome standards, Bloom’s
Taxonomy, level-of-difficulty, and a recommended time of completion. You can track student
performance in the WileyPLUS gradebook.

Test Bank
Each chapter of the test bank has between 130–175 questions that you can assign to students
in an exam or as graded practice. Question types include true/false, multiple-choice, fill-in-
the blank, and short answer questions. To help you more easily identify what questions you
want to assign, questions are tagged with learning objectives, professional AICPA and AACSB
outcome standards, Bloom’s Taxonomy, level-of-difficulty, and a recommended time of com-
pletion. You can track student performance in the WileyPLUS gradebook.

xiii
Acknowledgments
Auditing has benefited tremendously from the input of students who have used this text’s ma-
terial in class, manuscript reviewers, and those who have supported the writing. We are very
appreciative of all the suggestions and comments received. The thoughts, ideas, and recom-
mendations of reviewers, editorial staff, and ancillary authors is deeply appreciated.

Anne Albrecht Walied Keshk Dwayne Powell

Texas Christian University California State University—Fullerton Arkansas State University
Matthew Anderson Katherine Kinkela Matthew Reidenbach
Michigan State University Iona College Pace University—New York
Marie Blouin Milton Krivokuca Gary Schneider
Ithaca College California State University—Dominguez Hills California State University—Monterey Bay
A. Faye Borthick Ellen L. Landgraf Dan Schrag
Georgia State University Loyola University—Chicago Baldwin Wallace University
Billy Brewster Betsy Lin Edward B. Seibert
Texas State University Montclair State University Wesley College
Jeffrey R. Cohen Cathy Liu Jamie L. Seitz
Boston College University of Houston—Downtown University of Southern Indiana
Laurence DeGaetano Joe Looney Suzanne Seymoure
Montclair State University Hofstra University Saint Leo University, University Campus
Kristina Demek Roger Martin Philip Slater
University of Central Florida University of Virginia Forsyth Technical Community College
Lisa Derouin Linda McCann Vicki Stewart
Wisconsin Lutheran College Metropolitan State University Texas A&M University—Commerce
Raymond Elson Karen McDougal Paula Thomas
Valdosta State University Pennsylvania State University—Brandywine Middle Tennessee State University
Reza Espahbodi Linda McKeag Andrea Tietjen
Washburn University of Topeka University of Dubuque Caldwell College
Magdy Farag Mary Mindak Patricia Timm
California Polytechnic University—Pomona DePaul University Northwood University—Michigan
Dale Flesher Paula Mooney Madeline Trimble
University of Mississippi Savannah State University Illinois State University
Scott Fulkerson Grace Mubako Richard Turpen
University of California—Santa Barbara California Stata University—Sacramento University of North Carolina—Asheville
Lori Fuller Christine Noel Lisa Victoravich
West Chester University Metropolitan State University of Denver University of Denver
Abo-El-Yazeed Habib Connie O’Brien Jim Vogt
Minnesota State University—Manka Minnesota State University—Mankato University of Colorado—Denver
James Hansen Aimee Pernsteiner Rick Warne
Weber State University University of Wisconsin—Eau Claire University of Cincinnati
Julia Higgs Rossen Petkov Amanda Warren
Florida Atlantic University Lehman College University of Tennessee—Knoxville
Karen Hooks Lincoln Pinto Barrett Wheeler
Florida Atlantic University Concordia University Chicago Tulane University
Carol Jessup Marshall Pitman Fengyun Wu
University of Illinois—Springfield University of Texas—San Antonio Manhattan College
Bill Joyce
Bemidji State University

xiv
   Acknowledgments xv

Ancillary Authors, Eric Johnson Margaret B. Shackell-Dowell

University of Wyoming Ithaca College
Contributors, Proofreaders,
Joe Johnston Philip J. Slater
and Accuracy Checkers Illinois State University Forsyth Technical Community College
Sanaz Aghazadeh Brett Kawada Vicki Stewart
Louisiana State University San Diego State University Texas A & M University—Commerce
LuAnn Bean Jason MacGregor Jaclyn Strauss
Florida Institute of Technology Baylor University Purdue Global
Joe Brazel Linda McKeag Floran Syler
North Carolina State University University of Dubuque Azusa Pacific University
Rich Brody Anita Morgan Andrea Tietjen
The University of New Mexico Indiana University Caldwell College
Emily Cokeley Byron Pike Jim Vogt
Rochester Institute of Technology Minnesota State University—Mankato San Diego State University
Sheila Coomes Sridhar Ramamoorti Rick Warne
Kansas State University University of Dayton—Ohio University of Cincinnati
Kel-Ann Eyler Matthew Sargent Gail E. Wright
Georgia College and State University University of Texas—Arlington Ally Zimmerman
Paul Franklin Edward Seibert Northern Illinois University
Purdue Global Wesley College
Amber Gray Tim Seidel
Adrian College Brigham Young University
Frederick Harmon Jamie Seitz
University of Bridgeport University of Southern Indiana

We also want to thank several individuals for their help in We appreciate suggestions and comments from users—
moving this text from concept to publication. This work would instructors and students alike. Please send us your thoughts
not have come to fruition without the extensive support and and ideas about the text.
guidance of Emily Marcoux, Michael McDonald, Joel Hollen-
beck, Ed Brislin, Matt Origoni, Valerie Vargas, Sandra Rigby, Raymond Johnson Laura Wiley
Kirsten Loose, Terry Ann Tatro, Nicola Smith, and Jackie Henry Portland, Oregon Baton Rouge, Louisiana
at Aptara.
Table of Contents
1 Introduction and Overview of Audit Independence 2-12
Key Individuals and Independence Requirements 2-13
and Assurance 1-1 Employment or Association with an Attest Client 2-17
Nonattest Services 2-18
Assurance, Attestation, and Audit Services 1-3 SEC and PCAOB Independence Rules 2-20
Different Assurance Services 1-6 General Standards 2-23
Financial Statement Audits 1-6 Other Rules of Conduct for Members in
Compliance Audits 1-7 Public Practice 2-24
Operational (Performance) Audits 1-7 Accounting Principles Rule 2-25
Internal Audits 1-8 Fees and Other Types of Remuneration 2-25
Demand for Audit and Assurance Services 1-8 Confidential Information 2-26
Financial Statement Users 1-9 Auditor Liability Under Common Law 2-26
Sources of Demand for Audit and Assurance Services 1-10 Liability to Clients 2-27
Preparers and Auditors 1-11 Contract Law 2-27
Preparer Responsibility 1-11 Tort Law 2-28
Auditor Responsibility 1-11 Cases Illustrating Liability to Clients 2-28
Assurance Providers 1-12 Liability to Third Parties 2-29
The Role of Regulators and Regulations 1-13 Burden of Proof and Common Law Defenses 2-32
Securities and Exchange Commission (SEC) 1-13 Auditor Liability Under Statutory Law 2-33
Public Company Accounting Oversight Board (PCAOB) 1-13 The Securities Act of 1933 2-34
American Institute of Certified Public Accountants The Securities Act of 1934 2-35
(AICPA) 1-15 The Foreign Corrupt Practices Act of 1977 2-36
Financial Accounting Standards Board (FASB) 1-17 The Private Securities Litigation Reform Acts of 1995 and
Committee on Sponsoring Organizations of the Treadway 1998 2-36
Commission (COSO) 1-18 The Sarbanes-Oxley Act of 2002 2-37
National Association of State Boards of Accountancy Criminal Liability 2-39
(NASBA) and State Boards of Accountancy 1-18
Audit Report on Financial Statements 1-19
Reasonable Assurance and the Financial Statements 1-19 3 Risk Assessment Part I: Audit Risk
Materiality and the Financial Statements 1-20
The Auditorʼs Report on Financial Statements 1-20
and Audit Strategy 3-1
Audit Report on Internal Controls over
Client Acceptance and Continuance Decisions 3-3
Financial Reporting 1-25
Phases of an Audit 3-8
Reasonable Assurance and Internal Controls 1-25
Risk Assessment Phase 3-9
The Auditor’s Report on Internal Control over Financial
Risk Response Phase 3-9
Reporting 1-26
Concluding and Reporting on an Audit 3-10
The Audit Expectation Gap 1-28
Materiality 3-10
Qualitative and Quantitative Materiality 3-11
Setting Materiality 3-11
2 Professionalism and Professional Professional Skepticism and Audit Risk 3-14
Responsibilities 2-1 Professional Skepticism 3-15
Audit Risk 3-15
Professionalism and Accounting 2-3 The Audit Risk Model and Its Components 3-17
The Structure of the AICPA Code of Professional Audit Strategy 3-21
Conduct 2-5 Reliance on Controls Approach 3-22
Conceptual Framework for Members Substantive Approach 3-24
in Public Practice 2-7 Fraud Risk 3-25
Integrity and Objectivity 2-11 Incentives and Pressures to Commit a Fraud 3-27
xvi
   Table of Contents xvii

Opportunities to Perpetrate a Fraud 3-28

Attitudes and Rationalization to Justify a Fraud 3-29
6 Gaining an Understanding of
Fraud Risk Assessment Process 3-30 the Client’s System of Internal
Control 6-1
4 Risk Assessment Part II: Internal Control Defined 6-3
Understanding the Client 4-1 The COSO Framework 6-4
Inherent Limitations 6-6
Understanding the Client 4-3 Entity-Level Internal Controls 6-7
Gain an Understanding of the Entity 4-3 The Control Environment 6-7
Gain an Understanding of the Industry and Business Risk Assessment 6-10
Environment 4-8 Control Activities 6-11
Compliance with Laws and Regulations 4-10 Information and Communication 6-14
Client Approaches to Measuring Performance 4-12 Monitoring Activities 6-16
Profitability 4-12 Internal Control in Small Entities 6-17
Liquidity, Solvency, and Cash Flow 4-13 Transaction-Level Internal Controls 6-19
Analytical Procedures 4-14 Example Transaction Flows—Sales Process 6-19
Comparisons 4-14 Example Transaction Flows—Cash Receipts 6-21
Trend Analysis 4-15 Information Technology (IT) Controls 6-23
Common-Size Analysis 4-15 Benefits and Risks of IT Systems 6-23
Ratio Analysis 4-16 IT General Controls 6-24
Audit Data Analytics 4-20 IT Application Controls 6-25
Factors to Consider When Conducting IT-Dependent Manual Controls 6-27
Analytical Procedures 4-20 Documenting Internal Controls 6-29
Related Parties 4-22 Identifying Strengths and Weaknesses in a
Corporate Governance 4-23 System of Internal Controls 6-31
Internal Control and Information Technology 4-26 Management Letters 6-33
Closing Procedures 4-27

5 Audit Evidence 5-1 7 Audit Data Analytics 7-1

Management Assertions 5-3 Steps in Performing Audit Data Analytics 7-3

Characteristics of Audit Evidence 5-7 Step 1: Plan the Audit Data Analytics 7-5
Sufficient Audit Evidence 5-7 Step 2: Access and Prepare the Data for Audit Data
Appropriate Audit Evidence 5-8 Analytics 7-6
Audit Risk and Sufficient Appropriate Audit Evidence 5-9 Step 3: Consider the Relevance and Reliability of the
Procedures for Gathering Audit Evidence 5-10 Data Used 7-6
Inspection of Documents and Assets 5-11 Step 4: Perform the Audit Data Analytics 7-7
Observation 5-12 Step 5: Evaluate the Results and Draw Conclusions 7-8
Inquiry 5-12 Audit Documentation 7-9
Confirmation 5-13 Steps Associated with Accessing and Preparing Data for
Recalculation 5-15 Audit Data Analytics 7-11
Reperformance 5-16 Is the Data Complete? 7-11
Analytical Procedures 5-16 Does the Data Need to Be Cleaned? 7-11
Scanning 5-16 Key Questions to Be Addressed in Evaluating the Relevance
Audit Data Analytics (ADA) 5-16 and Reliability of Data Used in Audit Data Analytics 7-12
Using the Work of Others 5-18 Using Audit Data Analytics as a Risk Assessment
Using the Work of a Specialist 5-18 Procedure 7-13
Using the Work of Internal Auditors 5-20 Understanding the Risk Analysis Decision Tree 7-14
Using the Work of Another Auditor 5-23 What Do We Mean by Notable Items? 7-15
Documentation—Audit Working Papers 5-24 Tools for Searching for Notable Items 7-15
Permanent File 5-25 What to Do When ADA Identifies a Large Number of Items
Current File 5-26 for Further Consideration 7-16
xviii Table of Contents

Applying Audit Data Analytics as a Risk Assessment Timing of Substantive Procedures 9-14
Procedure 7-17 Extent of Substantive Procedures 9-16
Cluster Analysis 7-18 Auditing Accounting Estimates 9-19
Matching Information in Key Data Fields 7-25 Nature of Accounting Estimates 9-19
Regression Analysis 7-30 Risk Assessment Procedures for
Visualization 7-34 Accounting Estimates 9-21
Using Audit Data Analytics as a Substantive Test 7-37 Risk Response Procedures for Accounting Estimates 9-22
Applying Audit Data Analytics as a Substantive Test 7-38 Example of Auditing Accounting Estimates 9-24
Validating Sales Revenue and Accounts Receivable with Documenting Results of Substantive Procedures 9-26
Subsequent Cash Receipts 7-38
10 Risk Response: Evaluating Audit
8 Risk Response: Performing Tests Data Analytics and Audit Sampling
of Controls 8-1
for Substantive Tests 10-1
Using Audit Data Analytics versus Audit Sampling 10-3
Steps in Assessing Control Risk 8-3
When to Use Audit Data Analytics 10-3
Understand Entity-Level Controls 8-3
When to Use Audit Sampling 10-3
Understand the Flow of Transactions 8-3
Audit Sampling Defined 10-5
Identify What Can Go Wrong (WCGW) 8-4
Sampling Risk and Nonsampling Risk 10-6
Identify Relevant Controls to Test 8-5
Statistical and Nonstatistical Sampling 10-8
Determine Preliminary Audit Strategy 8-5
Sampling Methods 10-9
Perform Tests of Controls 8-5
Random Selection 10-9
Evaluate Evidence and Assess Control Risk 8-5
Systematic Selection 10-10
Reporting Findings 8-5
Haphazard Selection 10-11
Types of Controls 8-7
Professional Judgment in Selecting and Evaluating
Preventive and Detective Controls 8-7
Sample Items 10-11
Manual and Automated Controls 8-10
Factors That Influence the Sample Size—Substantive
Procedures for Testing Controls 8-13
Testing 10-11
Inquiry 8-13
A Basic Framework for Audit Sampling 10-14
Observation 8-14
Step 1: Determine the Objectives of the Substantive
Inspection of Physical Evidence 8-14
Test 10-14
Reperformance 8-14
Step 2: Determine the Substantive Audit Procedures to
Software-Based Audit Techniques 8-14
Perform 10-14
Selecting and Designing Tests of Controls 8-15
Step 3: Determine Whether to Audit a Sample
Which Controls Should Be Selected for Testing? 8-16
or the Entire Population 10-15
The Extent of Tests of Controls 8-17
Step 4: Define the Population and Sampling Unit 10-16
Timing of Tests of Controls 8-21
Applying Probability-Proportionate-to-Size Sampling
Benchmarking 8-22
for Substantive Testing 10-16
Selecting and Designing Tests of Controls—A Summary 8-23
Step 5: Choose the Audit Sampling Technique 10-17
Results of the Auditor’s Testing 8-26
Step 6: Determine Sample Size Using Professional
Documenting Conclusions 8-29
Judgment 10-18
Step 7: Select a Representative Sample 10-21
Step 8: Apply Audit Procedures 10-22
9 Risk Response: Performing Step 9: Evaluate Sample Results 10-22
Substantive Procedures 9-1 Applying Nonstatistical Sampling for Substantive
Testing 10-28
Audit Risk and Substantive Procedures 9-3 Step 5: Choose the Audit Sampling Technique 10-28
Risk Response at the Financial Statement Level 9-5 Step 6: Determine Sample Size Using
Nature of Substantive Procedures 9-7 Professional Judgment 10-29
Initial Procedures 9-8 Step 7: Select a Representative Sample 10-29
Substantive Analytical Procedures 9-9 Step 8: Apply Audit Procedures 10-30
Tests of Details 9-13 Step 9: Evaluate Sample Results 10-30
ADA and Substantive Procedures 9-13 Step 10: Document Conclusions 10-32
   Table of Contents xix

Appendix 10A: Applying Classical Variables Other Considerations Regarding the Entity
Sampling for Substantive Testing 10-33 and Its Environment 12-7
Step 5: Apply Classical Variables Sampling 10-33 Inherent Risks in the Purchasing Process 12-8
Step 6: Determine the Sample Size 10-34 Control Activities for Purchases 12-11
Step 7: Select a Random Sample 10-37 Example Transaction Flows—Credit Purchases 12-12
Step 8: Apply Audit Procedures 10-37 Identify What Can Go Wrong (WCGW) and Identify Key
Step 9: Evaluate the Sample Results 10-38 Controls—Purchases and Accounts Payable 12-15
Step 10: Document Results 10-39 Control Activities for Cash Disbursements 12-18
Example Transaction Flows—Cash Disbursements 12-18
11 Auditing the Revenue Process 11-1
Identify What Can Go Wrong (WCGW) and
Identify Key Controls—Cash Disbursements 12-19
Evaluated Receipt Settlement (ERS) 12-21
Nature of the Revenue Process 11-3
Initiating an ERS Transaction 12-21
Understanding the Entity and Its Environment 11-4
Receiving Goods 12-22
Understanding the Client’s Revenue Process 11-4
Recording Payables 12-22
Analytical Procedures 11-6
Electronic Payment 12-22
Other Considerations Regarding the Entity
Internal Controls in an ERS System 12-23
and Its Environment 11-8
Control Activities for Purchase Adjustments and
Inherent Risks in the Revenue Process 11-9
Purchasing Process Disclosures 12-24
Control Activities for Credit Sales 11-12
Purchase Returns and Allowances 12-24
Example Transaction Flows—Sales Process 11-13
Other Controls in the Purchasing Process 12-25
Identify What Can Go Wrong (WCGW) and Identify
Tests of Controls in the Purchasing Process and
Key Controls—Credit Sales and Accounts
Audit Strategy 12-26
Receivable 11-16
Tests of Controls in the Purchasing Process 12-26
Control Activities for Cash Receipts 11-18
Fraud Risk Assessment 12-27
Example Transaction Flows—Cash Receipts 11-19
Audit Data Analytics as a Risk Assessment Procedure 12-27
Identify WCGW and Identify Key Controls—Cash
The Risk of Material Misstatement and Audit
Receipts 11-21
Strategy 12-28
Control Activities for Sales Adjustments
Substantive Procedures for the Purchasing
and Revenue Process Disclosures 11-23
Process 12-28
Granting Sales Returns and Allowances 11-23
Initial Procedures 12-30
Determining Uncollectible Accounts 11-24
Substantive Analytical Procedures 12-30
Other Controls in the Revenue Process 11-24
Audit Data Analytics as a Substantive Test 12-31
Tests of Controls in the Revenue Process and
Tests of Details of Transactions 12-31
Audit Strategy 11-25
Tests of Details of Balances 12-32
Tests of Controls in the Revenue Process 11-25
Tests of Details of Presentation and Disclosure 12-33
Fraud Risk Assessment 11-26
Appendix 12A: Auditing Payroll 12-34
Audit Data Analytics as a Risk Assessment Procedure 11-27
Explain the Nature of Payroll Transactions and
The Risk of Material Misstatement and Audit Strategy 11-27
Balances 12-34
Substantive Tests for the Revenue Process 11-28
Understanding the Entity and Its Environment 12-35
Initial Procedures 11-30
Understanding the Client’s Payroll Process 12-35
Substantive Analytical Procedures 11-31
Analytical Procedures 12-36
Audit Data Analytics as a Substantive Test 11-31
Other Considerations Regarding the Entity and Its
Tests of Details of Transactions 11-32
Environment 12-36
Tests of Details of Balances 11-33
Inherent Risks Related to Payroll 12-37
Tests of Details of Presentation and Disclosure 11-38
Control Activities for Payroll 12-38
Example Transaction Flows—Payroll 12-38
12 Auditing the Purchasing and Identify What Can Go Wrong (WCGW) and Identify Key
Payroll Processes 12-1 Controls—Payroll 12-40
Tests of Controls in the Payroll Process and Audit
Nature of Purchase Transactions and Balances 12-3 Strategy 12-42
Understanding the Entity and Its Environment 12-4 Tests of Controls for Payroll 12-43
Understanding the Client’s Purchasing Process 12-4 Fraud Risk Assessment 12-43
Analytical Procedures 12-7 Audit Data Analytics Used in Fraud Risk Assessment 12-44
xx Table of Contents

The Risk of Material Misstatement and Audit

Strategy 12-44
14 Completing the Audit 14-1

Substantive Tests for the Payroll Process 12-45 Audit Procedures for Loss Contingencies 14-3
Initial Procedures 12-46 Subsequent Events 14-7
Substantive Analytical Procedures 12-47 Engagement Wrap-Up 14-10
Audit Data Analytics as a Substantive Test 12-47 Final Analytical Procedures 14-11
Tests of Details of Transactions 12-47 Final Evaluation of Audit Findings 14-11
Tests of Details of Balances 12-48 Completion of Working Paper Review 14-16
Tests of Disclosures 12-48 Engagement Quality Review 14-17
Completion of Documentation 14-17
Going Concern 14-18
13 Auditing Various Balance Sheet Management Representation and Communication
with Those Charged with Governance 14-21
Accounts (and Related Income Management Representation Letter 14-21
Statement Accounts) 13-1 Communication with Those Charged with Governance 14-24

Auditing Cash and Cash Equivalents 13-3

Understanding the Flow of Transactions 13-3 15 Reporting on the Audit 15-1
Understanding the Entity and Its Environment 13-3
Understanding the Results of Analytical Procedures 13-4 Standard Unmodified/Unqualified Audit Report 15-3
Assessing Inherent Risk 13-4 Additional Paragraph for the Standard Unmodified
Assessing Control Risk and Fraud Risk 13-4 Report 15-7
Determining an Audit Strategy 13-4 Going Concern Paragraph 15-7
Substantive Tests of Cash Balances 13-5 Consistency of Financial Statements 15-8
Auditing Inventory on the Balance Sheet 13-11 Emphasis Added at Discretion of the Auditor 15-10
Understanding the Flow of Transactions 13-12 Opinion Based in Part on the Report of Another
Understanding the Entity and Its Environment 13-12 Auditor 15-12
Understanding the Results of Analytical Modifying the Audit Opinion 15-14
Procedures 13-13 Departure from Applicable Financial Reporting
Assessing Inherent Risk 13-14 Framework 15-15
Assessing Control Risk and Fraud Risk 13-15 Scope Limitation 15-17
Determining an Audit Strategy 13-18 Subsequently Discovered Facts 15-22
Substantive Tests of Inventory 13-19 Subsequently Discovered Facts That Become Known
Auditing Property, Plant, and Equipment 13-28 Before the Report Release Date 15-22
Understanding the Flow of Transactions 13-28 Subsequently Discovered Facts That Become Known After
Understanding the Entity and Its Environment 13-29 the Report Release Date 15-24
Understanding the Results of Analytical Procedures 13-30 Reports on the Audit of icfr  15-26
Assessing Inherent Risk 13-31 Standard Unqualified Opinion on ICFR 15-26
Assessing Control Risk and Fraud Risk 13-31 Modified Opinion on ICFR 15-27
Determining an Audit Strategy 13-32 Compilation and Review Engagements 15-30
Substantive Tests for Property, Plant, and Equipment 13-32 Compilation of Financial Statements 15-30
Auditing Financing Activities 13-37 Review of Financial Statements 15-32
Understanding the Flow of Transactions 13-38
Understanding the Entity and Its Environment 13-38 Cloud 9 Inc. Audit A-1
Appendix A  
Understanding the Results of Analytical Cloud 9 Inc. Company Background A-1
Procedures 13-39 Personnel A-2
Assessing Inherent Risk 13-39 Financial Information A-2
Assessing Control Risk and Fraud Risk 13-40 Transcript of Meeting with David Collier A-4
Determining an Audit Strategy 13-41
Glossary  G-1
Substantive Tests of Long-Term Debt 13-41
Substantive Tests of Stockholders’ Equity 13-44 Index I-1
 Chapter 1
Introduction and
Overview of Audit
and Assurance
The Audit Process

Overview of Audit and Assurance

(Chapter 1)

Professionalism and Professional Responsibilities

(Chapter 2)

Client Acceptance/Continuance and Risk Assessment

(Chapters 3 and 4)

Gaining an Identify Significant

Set Planning
Understanding of Accounts and
Materiality
the Client Transactions

Gaining an Understanding
Make Preliminary
of the System of Internal Control
Risk Assessments
(Chapter 6)

Develop Responses to Risk and an Audit Strategy

Audit Data Analytics

Audit Evidence
(Chapter 5)

(Chapter 7)
Performing Tests of Controls Performing Substantive Procedures
(Chapter 8) (Chapter 9)

Audit Sampling for Substantive Tests

(Chapter 10)

Auditing the Auditing the Purchasing Auditing the Balance Sheet

Revenue Process and Payroll Processes and Related Income Accounts
(Chapter 11) (Chapter 12) (Chapter 13)

Completing and Reporting on the Audit

(Chapters 14 and 15)

Procedures Performed Near Drawing Audit

Reporting
the End of the Audit Conclusions

1-1
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