Auditing & Assurance Services - gbv.de & Assurance Services . ... The Role of Auditing 7 ... Society's Expectations and the Auditor's Responsibilities 44

EIGHTH EDITION

Auditing & AssuranceServices . S Y S T E M A T I C A P P R O A C H

William F. Messier, Jr.University of Nevada, Las Vegas

Department of Accountingand

Norwegian School of Economicsand Business Administration

Department of Accounting, Auditing and Law

Steven M. GloverBrigham Young University

Marriott School of ManagementSchool of Accountancy

Douglas F. PrawittBrigham Young University

Marriott School of ManagementSchool of Accountancy

MeGrawHill

McGraw-HillIrwin

Table of Contents

Introduction to Assurance andFinancial Statement Auditing 1

Chapter 1An Introduction to Assuranceand Financial Statement Auditing 3

The Study of Auditing 4The Demand for Auditing and Assurance 5

Principals and Agents 5The Role of Auditing 7

An Assurance Analogy: The Case of theHouse Inspector 8Seller Assertions, Information Asymmetry,

and Inspector Characteristics 8Desired Characteristics of the House

Inspection Service 9Relating the House Inspection Analogy

to Financial Statement Auditing 10Management Assertions and Financial

Statements 10Auditing, Attest, and Assurance Services

Defined 12Auditing 12Attestation 13Assurance 13

Fundamental Concepts in Conducting aFinancial Statement Audit 14Materiality 15Audit Risk 15Evidence Regarding Management

Assertions 16Sampling: Inferences Based on Limited

Observations 16The Audit Process 17

Overview of the Financial StatementAuditing Process 17

Major Phases of the Audit 19

The Unqualified/Unmodified AuditReport 22

Other Types of Audit Reports 24Conclusion 25Key Terms 26Review Questions 27Multiple-Choice Questions 27Problems 29Discussion Case 31Internet Assignment 32Hands-On Cases 32

The Financial Statement AuditingEnvironment 35

Types of Auditors 36External Auditors 36Internal Auditors 36Government Auditors 37Forensic Auditors 38

Types of Other Audit, Attest,and Assurance Services 38

Other Audit Services 39Attest Services 40Assurance Services 40Other Nonaudit Services 40

Public Accounting Firms 41Organization and Composition 41-

A Decade of Challenge and Change forFinancial Statement Auditors 42

Government Regulation 43Society's Expectations and the Auditor's

Responsibilities 44The Context of Financial Statement

Auditing 44Business as the Primary Context of

Auditing 44>A Model of Business 45

Corporate Governance 45xx

Contents X X I

Objectives, Strategies, Processes, Controls,Transactions, and Reports 46

A Model of Business Processes: FiveComponents 46

Organizations That Affect the PublicAccounting Profession 48Securities and Exchange Commission

(SEC) 50Public Company Accounting Oversight

Board (PCAOB) 50American Institute of Certified Public

Accountants (AICPA) 50Financial Accounting Standards Board

(FASB) 51International Auditing and Assurance

Standards Board (IAASB) 51International Accounting Standards

Board (IASB) 51Auditing Standards 52

Three Sets of Auditing Standards: The Rolesof the ASB, PCAOB, and IAASB 52

The 10 Generally Accepted AuditingStandards 53

Principles Underlying an Audit Conductedin Accordance with Generally AcceptedAuditing Standards 55

Auditing Standards and theAU Codification 56

Ethics, Independence, and the Codeof Professional Conduct 57

Conclusion 58Key Terms 58Review Questions 59Multiple-Choice Questions 60Problems 62Discussion Cases 64Internet Assignments 66Hands-On Cases 66

PART 2Audit Planning and BasicAuditing Concepts 67

Chapter 3Audit Planning, Types of Audit Tests,and Materiality 69

Client Acceptance and Continuance 70Prospective Client Acceptance 70

Client Continuance 71Preliminary Engagement Activities 71

Determine the Audit Engagement TeamRequirements 71

Assess Compliance with Ethical andIndependence Requirements 72

Establish an Understanding with theClient 72

Planning the Audit 76Audit Plan and Strategy 76Assess Business Risks 77Establish Materiality 77Consider Multilocations or Business

Units 77Assess the Need for Specialists 78Assess the Possibility of Illegal Acts 78Identify Related Parties 79Consider Additional Value-Added

Services 80Document the Overall Audit Strategy, Audit

Plan, and Prepare Audit Programs 80Supervision of the Audit 81Types of Audit Tests 82

Risk Assessment Procedures 82Tests of Controls 82Substantive Procedures 83Dual-Purpose Tests 84

Materiality 84Steps in Applying Materiality 85An Example 89

Key Terms 91Review Questions 91Multiple-Choice Questions 92Problems 94Discussion Cases 96Internet Assignments 97 —Hands-On Cases 97

Risk Assessment 99Audit Risk 100

The Audit Risk Model 100Use of the Audit Risk Model 102

The Auditor's Risk Assessment Process 104Management's Strategies, Objectives,

and Business Risks 104Business Risk and the Risk of Material

Miss tatemen t 105

xxii Contents

'Auditor's Risk Assessment Procedures 105The Importance of the Auditor

Understanding the Entity and ItsEnvironment 107

Evaluate the Entity's Risk AssessmentProcess 110

Assessing the Risk of MaterialMisstatement Due to Error or Fraud 111Types and Causes of Misstatements 111The Fraud Risk Assessment Process. 112Conditions Indicative of Fraud and

Fraud Risk Factors 114The Auditor's Response to the Results of

the Risk Assessments 117Evaluation of Audit Test Results 119Documentation of the Auditor's Risk

Assessment and Response 120Communications about Fraud to

Management, the Audit Committee,and Others 120

Key Terms 122Review Questions 123Multiple-Choice Questions 123Problems 125Discussion Case 127Internet Assignment 128Hands-On Cases 129

Evidence and Documentation 131The Relationship of Audit Evidence to the

Audit Report 132Management Assertions 133

Assertions about Classes of Transactionsand Events during the Period 134

Assertions about Account Balances at thePeriod End 135

Assertions about Presentation andDisclosure 136

The Concepts of Audit Evidence 137The Nature of Audit Evidence 137The Sufficiency and Appropriateness of

Audit Evidence 138The Evaluation of Audit Evidence 140

Audit Procedures for Obtaining AuditEvidence 140Inspection of Records or Documents 141

Inspection of Tangible Assets 142Observation 143Inquiry 143External Confirmation 144Recalculation 145Reperformance 145Analytical Procedures 145Scanning 145

Reliability of the Types of Evidence 146The Audit Testing Hierarchy 146

An "Assurance Bucket" Analogy 148Audit Documentation 150

Objectives of Audit Documentation 150Content of Audit Documentation 150Examples of Audit Documentation 152Format of Audit Documentation 154Organization of Audit Documentation 155Ownership of Audit Documentation 155Audit Document Archiving and

Retention 156Advanced Module 1: Analytical

Procedures 158Substantive Analytical Procedures 158Final Analytical Procedures 169

Advanced Module 2: SelectedFinancial Ratios Useful as AnalyticalProcedures 169Short-Term Liquidity Ratios 170Activity Ratios 170Profitability Ratios 171Coverage Ratios 172

Key Terms 173Review Questions 174Multiple-Choice Questions 174Problems 176Discussion Cases 179 —Internet Assignment 182Hands-On Cases 182

Understanding and AuditingInternal Control 183

Internal Control in a FinancialStatement Audit 185

Introduction 186

Contents XX111

Internal Control—An Overview 186Definition of Internal Control 186Controls Relevant to the Audit 186The Effect of Information Technology on

Internal Control 187The COSO Framework 187

Components of Internal Control 187Control Environment 188The Entity's Risk Assessment

Process 191Information System and

Communication 192Control Activities 192Monitoring of Controls 193

Planning an Audit Strategy 195Substantive Strategy 197Reliance Strategy 197

Obtain an Understanding of InternalControl 198Overview 198Understanding the Control

Environment 199Understanding the Entity's Risk

Assessment Process 199Understanding the Information System

and Communications 201Understanding Control Activities 201Understanding Monitoring of

Controls 201Documenting the Understanding of

Internal Control 202The Effect of Entity Size on Internal

Control 202The Limitations of an Entity's Internal

Control 203Assessing Control Risk 204

Identifying Specific Controls That Will BeRelied Upon 205

Performing Tests of Controls 205Concluding on the Achieved Level of

Control Risk 206Documenting the Achieved Level of

Control Risk 206An Example 206

Substantive Procedures 207Timing of Audit Procedures 208

Interim Tests of Controls 208

Interim Substantive Procedures 209Auditing Accounting Applications

Processed by ServiceOrganizations 209

Communication of InternalControl-Related Matters 211

Advanced Module 1: Types of Controlsin an IT Environment 212

General Controls 212Application Controls 213

Advanced Module 2: FlowchartingTechniques 216Symbols 217Organization and Flow 217

Key Terms 217Review Questions 218Multiple-Choice Questions 218Problems 220Discussion Case 222Hands-On Cases 223

Chapter 7Auditing Internal Control over FinancialReporting 225

Management Responsibilities underSection 404 226

Auditor Responsibilities under Section 404and AS5 226

Internal Control over Financial ReportingDefined 227

Internal Control Deficiencies Defined 227Control Deficiency 227Material Weakness 227Significant Deficiency 228Likelihood and Magnitude 228—

Management's Assessment Process 228Framework Used by Management to

Conduct Its Assessment 229Identify Financial Reporting Risks and

Related Controls 230Consider Which Locations to Include in

the Evaluation 230Evaluate Evidence About the Operating

Effectiveness oflCFR 231Reporting Considerations 231Management's Documentation 232

Performing an Audit of ICFR 233

XXIV Contents

Planning the Audit of ICFR 234The Role of Risk Assessment and the Risk

of Fraud 234Scaling the Audit 235Using the Work of Others 235

Using a Top-Down, Risk-BasedApproach 236Identify Entity-Level Controls 236Identifying Significant Accounts and

Disclosures and Their RelevantAssertions 237

Understanding Likely Sources ofMisstatements 238

Select Controls to Test 238Test the Design and Operating

Effectiveness of Controls 239Evaluating Design Effectiveness of

Controls 239Testing and Evaluating Operating

Effectiveness of Controls 239Evaluating Identified Control

Deficiencies 241An Example 243

Remediation of a Material Weakness 245Written Representations 245Auditor Documentation

Requirements 246Auditor Reporting on ICFR 246

Elements of the Auditor's Report 247Unqualified Report 247Adverse Report for a Material

Weakness 247Disclaimer for Scope Limitation 250

Other Reporting Issues 251Management's Report Incomplete or

Improperly Presented 251The Auditor Decides to Refer to the

Report of Other Auditors 251Subsequent Events 251Management's Report Contains

Additional Information 251Reporting on a Remediated Material

Weakness at an Interim Date 252Additional Required Communications in

an Audit of ICFR 252Advanced Module 1: Special Considerations

for an Audit of Internal Control 253

Use of Service Organizations 253Safeguarding of Assets 253

Advanced Module 2: Computer-AssistedAudit Techniques 254

Generalized Audit Software 254Custom Audit Software 255Test Data 255

Key Terms 256Review Questions 257Multiple-Choice Questions 258Problems 261Internet Assignments 267Hands-On Cases 267

Statistical and NonstatisticalSampling Tools for Auditing 269

Audit Sampling: An Overview andApplication to Tests of Controls 271

Introduction 272Definitions and Key Concepts 273

Audit Sampling 273Sampling Risk 273Confidence Level 275Tolerable and Expected Error 275Audit Evidence Choices That Do and Do

Not Involve Sampling 276Types of Audit, Sampling 277

Nonstatistical versus StatisticalSampling 277

Types of Statistical SamplingTechniques 278

Attribute Sampling Applied to TestlTofControls 279Planning 280Performance 288Evaluation 293

Nonstatistical Sampling for Tests ofControls 297Determining the Sample Size 297Selecting the Sample Items 298Calculating the Computed Upper

Deviation Rate 298Conclusion 299

Contents XXV

Advanced Module 1: Considering theEffect on a Sample Size of a SmallPopulation 299

Advanced Module 2: ComparingTerminology for Attribute Samplingbetween ACL and Sampling Tables 300

Key Terms 300Review Questions 301Multiple-Choice Questions 302Problems 304Discussion Case 308Hands-On Cases 308

Chapter 9Audit Sampling: An Applicationto Substantive Tests of AccountBalances 311

Sampling for Substantive Tests of Detailsof Account Balances 312

Monetary-Unit Sampling 313Advantages 314Disadvantages 314Applying Monetary-Unit Sampling 314Planning 315Performance 319Evaluation 321

Nonstatistical Sampling for Tests ofAccount Balances 328Identifying Individually Significant

Items 328Determining the Sample Size 330Selecting Sample Items 330Calculating the Sample Results 331An Example of Nonstatistical

Sampling 332The Rise and Fall of Statistical Audit

Sampling 333Advanced Module 1: Classical Variables

Sampling 334Advantages 336Disadvantages 336Applying Classical Variables

Sampling 336Advanced Module 2: Comparing

Terminology for Monetary-UnitSampling between ACL and ManualCalculation 340

Key Terms 341Review Questions 342Multiple-Choice QuestionsProblems 344Discussion Cases 347Hands-On Cases 348

342

Auditing BusinessProcesses 349

Auditing the Revenue Process 351Revenue Recognition 353Overview of the Revenue Process 354

Types of Transactions and FinancialStatement Accounts Affected 355

Types of Documents and Records 357The Major Functions 361Key Segregation of Duties 363

Inherent Risk Assessment 364Industry-Related Factors 364The Complexity and Contentiousness of

Revenue Recognition Issues 364The Difficulty of Auditing Transactions

and Account Balances 365Misstatements Detected in Prior

Audits 365Control Risk Assessment 365

Understand and Document InternalControl 365

Plan and Perform Tests of Controls 366Set and Document Control Risk 367

Control Activities and Tests of Controls^Revenue Transactions 367

Occurrence of Revenue Transactions 369Completeness of Revenue

Transactions 370Authorization of Revenue

Transactions 370Accuracy of Revenue Transactions 370Cutoff of Revenue Transactions 371Classification of Revenue

Transactions 371Control Activities and Tests of Controls—

Cash Receipts Transactions 371

xxvi Contents

Occurrence of Cash ReceiptsTransactions 371

Completeness of Cash ReceiptsTransactions 373

Authorization of Cash Discounts 373Accuracy of Cash Receipts

Transactions 374Cutoff of Cash Receipts Transactions 374Classification of Cash Receipts 374

Control Activities and Tests ofControls—Sales Returns and AllowancesTransactions 374

Relating the Assessed Level of Control Riskto Substantive Procedures 375

Auditing Revenue-Related Accounts 375Substantive Analytical Procedures 376Tests of Details of Classes of Transactions,

Account Balances, and Disclosures 378Completeness 379Cutoff 380Existence 381Rights and Obligations 381Valuation and Allocation 381Classification 382Other Presentation and Disclosure

Assertions 383The Confirmation Process—Accounts

Receivable 384Types of Confirmations 385Timing 386Confirmation Procedures 387Alternative Procedures 388

Auditing Other Receivables 389Evaluating the Audit Findings—Revenue-

Related Accounts 389Key Terms 390Review Questions 391Multiple-Choice Questions 391Problems 393Discussion Cases 397Internet Assignments 398Hands-On Cases 399

Chapter 11Auditing the Purchasing Process 401

Expense and Liability Recognition 402

Overview of the Purchasing Process 402Types of Transactions and Financial

Statement Accounts Affected 403Types of Documents and Records 404The Major Functions 407The Key Segregation of Duties 409

Inherent Risk Assessment 410Industry-Related Factors 410Misstatements Detected in Prior

Audits 410Control Risk Assessment 411


Plan and Perform Tests of Controls 412Set and Document Control Risk 412

Control Activities and Tests of Controls—Purchase Transactions 413Occurrence of Purchase Transactions 413Completeness of Purchase

Transactions 415Authorization of Purchase

Transactions 415Accuracy of Purchase Transactions 415Cutoff of Purchase Transactions 416Classification of Purchase


Cash Disbursement Transactions 416Occurrence of Cash Disbursement

Transactions 416Completeness of Cash Disbursement

Transactions 418Authorization of Cash Disbursement

Transactions 418Accuracy of Cash Disbursement

Transactions 418Cutoff of Cash Disbursement

Transactions 418Classification of Cash Disbursement


Purchase Return Transactions 419Relating the Assessed Level of Control Risk

to Substantive Procedures 419Auditing Accounts Payable and Accrued

Expenses 420Substantive Analytical Procedures 421

Contents xxvii

Tests o£ Details of Classes of Transactions,Account Balances, and Disclosures 421

Completeness 422Existence 424Cutoff 424Rights and Obligations 425Valuation 425Classification and

Understandability 425Other Presentation Disclosure

Assertions 425Accounts Payable Confirmations 426Evaluating the Audit Findings—Accounts

Payable and Related 427Advanced Module: Auditing the Tax

Provision and Related Balance SheetAccounts 428

Key Terms 430Review Questions 431Multiple-Choice Questions 431Problems 433Discussion Case 436Internet Assignments 437Hands-On Cases 437

Chapter 12Auditing the Human ResourceManagement Process 439

Overview of the Human ResourceManagement Process 440Types of Transactions and Financial

Statement Accounts Affected 441Types of Documents and Records 441The Major Functions 442The Key Segregation of Duties 444

Inherent Risk Assessment 445Control Risk Assessment 446


Plan and Perform Tests of Controls 447Set and Document the Control Risk 448

Control Activities and Tests of Controls—Payroll Transactions 448Occurrence of Payroll Transactions 448Authorization of Payroll

Transactions 448

Accuracy of Payroll Transactions 450Classification of Payroll

Transactions 450Relating the Assessed Level of Control Risk

to Substantive Procedures 450Auditing Payroll-Related Accounts 450Substantive Analytical Procedures 451Tests of Details of Classes of Transactions,

Account Balances, and Disclosures 452Payroll Expense Accounts 453Accrued Payroll Liabilities 453

Evaluating the Audit Findings—Payroll-Related Accounts 456

Advanced Module: Share-BasedCompensation 456

Key Terms 458Review Questions 458Multiple-Choice Questions 459Problems 460Discussion Cases 463Internet Assignment 465Hands-On Cases 465

Auditing the Inventory ManagementProcess 467

Overview of the Inventory ManagementProcess 468Types of Documents and Records 469The Major Functions 471The Key Segregation of Duties 472

Inherent Risk Assessment 473Industry-Related Factors 473Engagement and Operating

Characteristics 473Control Risk Assessment 475


Plan and Perform Tests of Controls 475Set and Document the Control Risk 476

Control Activities and Tests of Controls—Inventory Transactions 476

Occurrence of InventoryTransactions 476

Completeness of InventoryTransactions 476

XXVU1 Contents

Authorization of InventoryTransactions 478

Accuracy of Inventory Transactions 478Cutoff of Inventory Transactions 478Classification of Inventory

Transactions 479Relating the Assessed Level of Control Risk

to Substantive Procedures 479Auditing Inventory 479Substantive Analytical Procedures 480Auditing Standard Costs 481

Materials 481Labor 482Overhead 482

Observing Physical Inventory 482Tests of Details of Classes of Transactions,

Account Balances, and Disclosures 483Accuracy 485Cutoff 485Existence 485Completeness 485Rights and Obligations 486Valuation and Allocation 486Classification and Understandability 486Other Presentation and Disclosure

Assertions 487Evaluating the Audit Findings—

Inventory 487Key Terms 488Review Questions 488Multiple-Choice Questions 489Problems 491Discussion Case 495Internet Assignments 495Hands-On Cases 495

Chapter 14Auditing the Financing/InvestingProcess: Prepaid Expenses, IntangibleAssets, and Property, Plant, andEquipment 497

Auditing Prepaid Expenses 498Inherent Risk Assessment—Prepaid

Expenses 498Control Risk Assessment—Prepaid

Expenses 498

Substantive Procedures—PrepaidInsurance 499Substantive Analytical Procedures for

Prepaid Insurance 499Tests of Details of the Prepaid

Insurance 499Existence and Completeness 499Rights and Obligations 500Valuation 500Classification 500

Auditing Intangible Assets 501Inherent Risk Assessment—Intangible

Assets 501Control Risk Assessment—Intangible

Assets 502Substantive Procedures—Intangible

Assets 502Substantive Analytical Procedures for

Intangible Assets 502Tests of Details of Intangible Assets 502

Auditing the Property ManagementProcess 504Types of Transactions 504Overview of the Property Management

Process 505Inherent Risk Assessment—Property

Management Process 506Complex Accounting Issues 506Easy and Difficult Transactions to

Audit 506Misstatements Detected in Prior

Audits 506Control Risk Assessment—Property

Management Process 507Occurrence and Authorization JJ)7Completeness 508Segregation of Duties 508

Substantive Procedures—Property, Plant,and Equipment 509Substantive Analytical Procedures—

Property, Plant, and Equipment 509Tests of Details of Transactions, Account

Balances, and Disclosures—Property,Plant, and Equipment 510

Evaluating the Audit Findings—Property,Plant, and Equipment 513

Contents XXIX

Key Terms 514Review Questions 514Multiple-Choice QuestionsProblems 517Discussion Case 519Internet Assignments 520Hands-On Cases 520

515

Auditing the Financing/InvestingProcess: Long-Term Liabilities,Stockholders' Equity, and IncomeStatement Accounts 523

Auditing Long-Term Debt 524Inherent Risk Assessment—Long-Term

Debt 525Control Risk Assessment—Long-Term

Debt 525Assertions and Related Control

Activities 525Substantive Procedures—Long-Term

Debt 527Auditing Stockholders' Equity 529Control Risk Assessment—Stockholders'

Equity 530Assertions and Related Control

Activities 530Segregation of Duties 531

Auditing Capital-Stock Accounts 531Occurrence and Completeness 531Valuation 532Completeness of Disclosures 532

Auditing Dividends 532Auditing Retained Earnings 533Auditing Income Statement Accounts 533Assessing Control Risk for Business

Processes—Income StatementAccounts 534

Substantive Procedures—IncomeStatement Accounts 534Direct Tests of Balance Sheet

Accounts 534Substantive Analytical Procedures for

Income Statement Accounts 535Tests of Selected Account Balances 536

Key Terms 536

Review Questions 537Multiple-Choice Questions 537Problems 539Discussion Case 542Internet Assignment 542Hands-On Cases 543

Chapter 16Auditing the Financing/InvestingProcess: Cash and Investments 545

Auditing Cash 546Types of Bank Accounts 547

General Cash Account 547Imprest Cash Accounts 547Branch Accounts 547

Control Risk Assessment—Cash 548Substantive Procedures—Cash 548

Substantive Analytical Procedures—Cash 548

Substantive Tests of Details ofTransactions and Balances—Cash 549

Auditing the General Cash Account 550Fraud-Related Audit Procedures 554Auditing a Payroll or Branch Imprest

Account 557Auditing a Petty Cash Fund 557Disclosure Issues for Cash 559

Auditing Investments 559Control Risk Assessment—Investments 560

Assertions and Related ControlActivities 560

Segregation of Duties 561Substantive Procedures—Investments 562

Substantive Analytical Procedures—Investments 562

Tests of Details—Investments 562Advanced Module: Auditing Fair Value

Measurements 564Understanding How Management Makes

Fair Value Measurements 566Considering Whether Specialized Skills or

Knowledge Is Required 567Testing the Entity's Fair Value

Measurements 567Evaluating the Reasonableness of the

Fair Value Measurements 568

XXX Contents

Key Terms 568Review Questions 569Multiple-Choice QuestionsProblems 571Internet Assignments 576Hands-On Cases 576

569

Review Questions 600Multiple-Choice QuestionsProblems 602Discussion Cases 607Internet Assignments 610Hands-On Cases 610

600

Completing the Audit andReporting Responsibilities 577

Chapter 17Completing the Audit Engagement 579

Review for Contingent Liabilities 580Audit Procedures for Identifying

Contingent Liabilities 581Legal Letters 581

Commitments 584Review of Subsequent Events for Audit of

Financial Statements 584Dual Dating 586Audit Procedures for Subsequent, Events 586

Review of Subsequent Events for theAudit of Internal Control over FinancialReporting 587

Final Evidential Evaluation 588Final Analytical Procedures 588Representation Letter 589Working Paper Review 589Final Evaluation of Audit Results 592Evaluating Financial Statement

Presentation and Disclosure 593Independent Engagement Quality

Review 594Archiving and Retention 594Going Concern Considerations 594

Communications with Those Charged withGovernance and Management 596Communications Regarding the Audit

of Internal Control over FinancialReporting 597

Management Letter 598Subsequent Discovery of Facts Existing at

the Date of the Auditor's Report 598Key Terms 599

Reports on Audited FinancialStatements 613

Reporting on the Financial StatementAudit: The Standard Unqualified/Unmodified Audit Report 614

The Standard Unqualified Audit Reportfor Public Companies 614

The Standard Unmodified Audit Reportfor All Entities Other Than PublicCompanies 615

Explanatory Language Added to theStandard Unqualified/UnmodifiedFinancial Statement Audit Report 616Modified Wording for Opinion Based

in Part on the Report of AnotherAuditor 617

Circumstances Requiring ExplanatoryLanguage in an AdditionalParagraph 618

Departures from an Unqualified/Unmodified Financial Statement AuditReport 621

Conditions for Departure 621Types of Financial Statement Audit

Reports Other than Unqualified/Unmodified 622

The Effect of Materiality on FinancialStatement Reporting 622

Discussion of Conditions Requiring OtherTypes of Financial Statement AuditReports 624Scope Limitation 624Statements Not in Conformity with

GAAP 625Auditor Not Independent 627

Special Reporting Issues 627Reports on Comparative Financial

Statements 628

Contents XXXI

Different Reports on ComparativeFinancial Statements 628

A Change in Report on the Prior-PeriodFinancial Statements 629

Report by a Predecessor Auditor 629Other Information in Documents Containing

Audited Financial Statements 630Special Reports Relating to Financial

Statements 630Financial Statements Prepared According

to a Special Purpose Framework 631Specified Elements, Accounts, or Items of

a Financial Statement 631Compliance Reports Related to Audited

Financial Statements 632Key Terms 633Review Questions 634Multiple-Choice Questions 634Problems 637Discussion Case 641Hands-On Cases 642

PART 7ProfessionalResponsibilities 643

Chapter 19Professional Conduct, Independence,and Quality Control 645

Ethics and Professional Conduct 646Ethics and Professional Conduct

Defined 646Theories of Ethical Behavior 647 .Example—An Ethical Challenge 648

An Overview of Ethics and Professionalismin Public Accounting 650A Tale of Two Companies 650Standards for Auditor

Professionalism 651The AICPA Code of Professional Conduct:

A Comprehensive Framework forAuditors 653Principles of Professional Conduct 653Rules of Conduct 655

Independence, Integrity, andObjectivity 656

Independence 656 ""Integrity and Objectivity 669

General Standards and AccountingPrinciples 670

General Standards and Compliance withStandards 670

Accounting Principles 671Responsibilities to Clients 671

Confidential Client Information 671Contingent Fees 672

Other Responsibilities and Practices 672Acts Discreditable 672Advertising and Other Forms of

Solicitation 673Commissions and Referral Fees 673Form of Organization and Name 674Disciplinary Actions 674Don't Lose Sight of the Forest for the

Trees 675Quality Control Standards 675

System of Quality Control 676Elements of Quality Control 677PCAOB Inspections of Registered Public

Accounting Firms 679Key Terms 679Review Questions 681Multiple-Choice Questions 681Problems 684Discussion Cases 686Internet Assignments 688Hands-On Cases 689

Legal Liability 691Introduction 692 —

Historical Perspective 692Overview of Auditor Legal Liability 693

Common Law—Clients 695Breach of Contract—Client Claims 695Negligence—Client Claims 695Fraud—Client Claims 698

Common Law—Third Parties 698Ordinary Negligence—Third-Party

Claims 699Fraud and Gross Negligence—Third-

Party Claims 705

xxxu Contents

Damages under Common Law 706Statutory Law—Civil Liability 706

Securities Act of 1933 707Securities Exchange Act of 1934 709Private Securities Litigation Reform

Act of 1995, the Securities LitigationUniform Standards Act of 1998, andThe Class Action Fairness Act of2005 712

Sarbanes-Oxley Act of 2002 713SEC and PCAOB Sanctions 714Foreign Corrupt Practices Act 716Racketeer Influenced and Corrupt

Organizations Act 716Statutory Law—Criminal Liability 717Key Terms 718Review Questions 719Multiple-Choice Questions 719Problems 722Discussion Cases 726Hands-On Cases 726

PART 8Assurance, Attestation, andInternal Auditing Services 727

Assurance, Attestation, and InternalAuditing Services 729

Assurance Services 730Types of Assurance Services 731

Attest Engagements 732Types of Attest Engagements 733

Attestation Standards 734General Standards 734Standards of Field Work 735Standards of Reporting 735

Reporting on an Entity's Internal Controlover Financial Reporting 735Conditions for Conducting an

Engagement 736Examination Engagement 736

Reporting on Management's Assertionabout Internal Control 737

Financial Forecasts and Projections 737Types of Prospective Financial

Statements 738Examination of Prospective Financial

Statements 739Agreed-Upon Procedures for Prospective

Financial Statements 740Compilation of Prospective Financial

Statements 740Accounting and Review Services 742

Compilation of FinancialStatements 743

Review of Financial Statements 744Internal Auditing 746

Internal Auditing Defined 747The Institute for Internal Auditors 747IIA Standards 747Code of Ethics 749Internal Auditors' Roles 749Internal Audit Product Offerings 752Interactions between Internal and

External Auditors 752Advanced Module: Examples of Assurance

Services—Trust Services and PrimePlusServices 754

Trust Services 754CPA WebTrust 755SysTrust 757CPA PrimePlus Services 757

Key Terms 759Review Questions 760Multiple-Choice Questions 760Problems 763Discussion Case 767Internet Assignments 767Hands-On Cases 768

Professional Judgment Module (availableonline at www.mhhe.com/messier8e)

Index 769