1
,• Table of Contents
f f
Chapterf1:fAnfIntroductionftofAssurancefandfFinancialfStatementfAuditing
Chapterf2:fThefFinancialfStatementfAuditingfEnvironment
Chapterf3:fAuditfPlanning,fTypesfoffAuditfTests,fandfMateriality
Chapterf4:fRiskfAssessment
Chapterf5:fEvidencefandfDocumentation
Chapterf6:fInternalfControlfinfafFinancialfStatementfAudit
Chapterf7:fAuditingfInternalfControlfoverfFinancialfReporting
Chapterf8:fAuditfSampling:fAnfOverviewfandfApplicationftofTestsfoffControls
Chapterf9:fAuditfSampling:fAnfApplicationftofSubstantivefTestsfoffAccountfBalances
Chapterf10:fAuditingfthefRevenuefProcess
Chapterf11:fAuditingfthefPurchasingfProcess
Chapterf12:fAuditingfthefHumanfResourcefManagementfProcess
Chapterf13:fAuditingfthefInventoryfManagementfProcess
Chapterf14:fAuditingfthefFinancing/InvestingfProcess:PrepaidfExpenses,fIntangiblefAssets,fandfProperty,fPlant,fandfEquip
ment
Chapterf15:fAuditingfthefFinancing/InvestingfProcess:Long-
TermfLiabilities,fStockholders’fEquity,fandfIncomefStatementfAccounts
Chapterf16:fAuditingfthefFinancing/InvestingfProcess:fCashandfInvestments
Chapterf17:fCompletingfthefAuditfEngagement
Chapterf18:fReportsfonfAuditedfFinancialfStatements
Chapterf19:fProfessionalfConduct,fIndependence,fandfQualityfManagement
Chapterf20:fLegalfLiability
Chapterf21:fAssurance,fAttestation,fandfInternalfAuditingfServices
2
,CHAPTERf1
ANf INTRODUCTIONf TOf ASSURANCEf ANDf FINANCIALf STATEMENTf AUDITING
AnswersftofReviewfQuestions
1-1 Thefstudyfoffauditingfisfmorefconceptualfinfnaturefcomparedftofotherfaccountingfcourses.fR
atherfthanffocusingfonflearningfthefrules,ftechniques,fandfcomputationsfrequiredftofprepareffinancia
lfstatements,fauditingfemphasizesflearningfafframeworkfoffanalyticalfandflogicalfskillsftofevaluatefthef
relevancefandfreliabilityfoffthefsystemsfandfprocessesfresponsiblefforffinancialfinformation,fasfwellf
asfthefinformationfitself.fTofbefsuccessful,fstudentsfmustflearnfthefframeworkfandfthenflearnftofusefl
ogicfandfcommonfsensefinfapplyingfauditingfconceptsftofvariousfcircumstancesf andfsituations.
Understandingfauditingfcanfimprovefthefdecisionfmakingfabilityfoffconsultants,fbusinessfma
nagers,fandfaccountantsfbyfprovidingfafframeworkfforfevaluatingfthefusefulnessfandfreliabil
ityfoffinformation.
1-2 Therefisfafdemandfforfauditingfinfaffree-
marketfeconomyfbecausefthefagencyfrelationshipfbetweenfanfabsenteefownerfandfafmanagerfpro
ducesfafnaturalfconflictfoffinterestfdueftofthefinformationfasymmetryfthatfexistsfbetweenfthefownerf
andfmanager.fAsfafresult,fthefagentfagreesftofbefmonitoredfasfpartfoffhis/herfemploymentfcontract.f
Auditingfappearsftofbefafcost-effectivefformfoffmonitoring.
Thefempiricalfevidencefsuggestsfauditingfwasfdemandedfpriorftofgovernmentfregulationfsuc
hfasfstatutoryfauditfrequirements.fAdditionally,fmanyfprivatefcompaniesfandfotherfentitiesfnotfsubje
ctftofgovernmentfauditingfregulationsfalsofdemandfauditing.
1-3 Thefagencyfrelationshipfbetweenfanfownerfandfmanagerfproducesfafnaturalfconflictfoffinte
restfbecausefoffdifferencesfinftheftwofparties’fgoalsfandfbecausefoffinformationfasymmetryfthatfexi
stsfbetweenfthem.fThatfis,fthefmanagerfgenerallyfhasfmorefinformationfaboutfthef‘true’ffinancialfpo
sitionfandfresultsfoffoperationsfoffthefentityfthanfthefabsenteefownerfdoes.fIffbothfpartiesfseekftofm
aximizeftheirfownfself-
interest,fitfisflikelyfthatfthefmanagerfwillfnotfactfinfthefbestfinterestfoffthefownerfandfmayfmanipulateft
hefinformationfprovidedftofthefownerfaccordingly.
1-4 Independencefisfanfimportantfstandardfforfauditors.fIffanfauditorfisfnotfindependentfoffthefc
lient,fusersfmayflosefconfidencefinfthefauditor’sfabilityftofreportftruthfullyfonftheffinancialfstatements
,fandfthefauditor’sfworkflosesfitsfvalue.fFromfanfagencyfperspective,fiffthefprincipalf(owner)fknowsft
hatfthefauditorfisfnotfindependent,fthefownerfwillfnotftrustfthefauditor’sfwork.
Thus,fthefagentfwillfnotfhirefthefauditorfbecausefthefauditor’sfreportfwillfnotfbefeffectivefinfreducingfinf
ormationfriskffromfthefperspectivefoffthefowner.
1-5 Auditingf(broadlyfdefined)fisfafsystematicfprocessfoffobjectivelyfobtainingfandfevaluatin
gfevidencefregardingfassertionsfaboutfeconomicfactionsfandfeventsftofascertainfthefdegreefoffcor
respondencefbetweenfthosefassertionsfandfestablishedfcriteriafandfcommunicatingfthefresultsft
ofinterestedf users.
Assurancefisfengagementfinfwhichfafpractitionerfexpressesfafconclusionfdesignedftofenha
ncefthefdegreefoffconfidencefoffthefintendedfusersfotherfthanfthefresponsiblefpartyfaboutfthefoutcom
efoffthefevaluationforfmeasurementfoffafsubjectfmatterfagainstfcriteria.
Examplesfoffassurancefservicesfarefassurancef(audit)fofffinancialfstatements,fassurancefo
ffprospectiveffinancialfinformation,fassurancefoffreportingfonfinternalfcontrol,fassurancefoffsustaina
bilityfreporting,fandfassurancefoffelectronicfcommerce.
3
, 1-6 Thefphrasefsystematicfprocessfimpliesfthatftherefshouldfbefafwell-
planned,flogicalfapproachfforfconductingfanfauditfthatfinvolvesfobjectivelyfobtainingfandfevaluati
ngfevidence.
1-7 Materiality:f"Omissionsforfmisstatementsfoffitemsfarefmaterialfifftheyfcould,findividuallyforfc
ollectively,finfluencefthefeconomicfdecisionsfoffusersftakenfonfthefbasisfofftheffinancialfstatements.f
Materialityfdependsfonfthefsizefandfnaturefoffthefomissionforfmisstatementfjudgedfinfthefsurroundin
gfcircumstances.fThefsizeforfnaturefoffthefitem,forfafcombinationfoffboth,fcouldfbefthef determiningffac
tor."f(IASB).
Auditfriskfisfdefinedfasfthefriskfthatfthefauditorfexpressesfanfinappropriatefauditfopinionfwhe
nftheffinancialfstatementsfarefmateriallyf misstatedf(ISAf200).
Thefauditfreportfstatesfthatfthefauditorfobtainsf“reasonablefassurance”fwhetherftheffinancia
lfstatementsfareffreeffromf“material”fmisstatement.fTheftermfreasonablefassurancefinformsfthefrea
derfthatftherefisfsomeflevelfoffriskfthatfthefauditfdidfnotfdetectfallfmaterialfmisstatements.fInfaddition,f
thefauditor’sfopinionfcommonlyfusesfthefwordingfthatftheffinancialfstatementsfpresentffairly,f“infallfm
aterialfrespects.”fThesefphrasesfcommunicateftofthirdfpartiesfthatfthefauditfreportfisflimitedftofmateri
alfinformation.
1-8 Onfmostfaudits,fitfisfnotffeasibleforfcost-
effectiveftofauditfallftransactions.fForfexample,finfafsmallfbusiness,fthefauditorfmightfbefableftofexam
inefallftransactionsfthatfoccurredfduringfthefperiod.fHowever,fitfisfunlikelyfthatfthefownerfoffthefbusin
essfcouldfaffordftofpayfforfsuchfanfextensivefaudit.fForfaflargeforganization,fthefsheerfvolumefofftran
sactionsfpreventsfthefauditorffromfexaminingfeveryftransaction.fThus,ftherefisfaftrade-
offfbetweenfthefexactnessforfprecisionfoffthefauditfandfitsfcost.
1-9 Thefmajorfphasesfoffthefauditfare:
• Clientf acceptance/continuancef andf establishingf engagementf terms
• Preplanning
• Assessfrisksfandfestablishfmateriality
• Planfthefaudit
• Considerfinternalfcontrol
• Auditfbusinessfprocessesfandfrelatedfaccounts
• Completefthefaudit
• Evaluatefresultsfandfissuefauditfreport
1-10 Thefauditor’sfunderstandingfoffthefentityfandfitsfenvironmentfincludesfknowledgefabo
ut:f(1)fthefnaturefoffthefentity,f(2)fitsfobjectivesfandfstrategies,f(3)fitsfindustry,fregulatory,fandfothe
rfexternalffactors,f(4)fitsfmanagement,f(5)fitsfgovernance,f(6)fitsfmeasurementfandfperformancef
process,fandf(7)fitsfbusinessf processes.
1-11 Sometimesfauditorsfwillffacefsituationsfwherefnofstandardfauditfprocedurefexists,fsuchfasft
hefexampleffromftheftextfoffverifyingfthefinventoryfoffreindeer.fSuchfcircumstancesfrequirefthatfthef
auditorfpossessfcreativityfandfinnovationfwhenfplanningfandfadministeringfauditfproceduresfwher
eflittleforfnofprecedentfexists.fEveryfclientfisfdifferent,fandfapplyingfauditingfconceptsfinfdifferentfsit
uationsfrequiresflogicfandfcommonfsense,fandffrequentlyfcreativityfandfinnovation.
SolutionsftofProblems
1-12 Thefmemofshouldfciteftheffollowingffacts:
• Therefisfafhistoricalfrelationshipfbetweenfaccountingfandfauditing.
4
,• Table of Contents
f f
Chapterf1:fAnfIntroductionftofAssurancefandfFinancialfStatementfAuditing
Chapterf2:fThefFinancialfStatementfAuditingfEnvironment
Chapterf3:fAuditfPlanning,fTypesfoffAuditfTests,fandfMateriality
Chapterf4:fRiskfAssessment
Chapterf5:fEvidencefandfDocumentation
Chapterf6:fInternalfControlfinfafFinancialfStatementfAudit
Chapterf7:fAuditingfInternalfControlfoverfFinancialfReporting
Chapterf8:fAuditfSampling:fAnfOverviewfandfApplicationftofTestsfoffControls
Chapterf9:fAuditfSampling:fAnfApplicationftofSubstantivefTestsfoffAccountfBalances
Chapterf10:fAuditingfthefRevenuefProcess
Chapterf11:fAuditingfthefPurchasingfProcess
Chapterf12:fAuditingfthefHumanfResourcefManagementfProcess
Chapterf13:fAuditingfthefInventoryfManagementfProcess
Chapterf14:fAuditingfthefFinancing/InvestingfProcess:PrepaidfExpenses,fIntangiblefAssets,fandfProperty,fPlant,fandfEquip
ment
Chapterf15:fAuditingfthefFinancing/InvestingfProcess:Long-
TermfLiabilities,fStockholders’fEquity,fandfIncomefStatementfAccounts
Chapterf16:fAuditingfthefFinancing/InvestingfProcess:fCashandfInvestments
Chapterf17:fCompletingfthefAuditfEngagement
Chapterf18:fReportsfonfAuditedfFinancialfStatements
Chapterf19:fProfessionalfConduct,fIndependence,fandfQualityfManagement
Chapterf20:fLegalfLiability
Chapterf21:fAssurance,fAttestation,fandfInternalfAuditingfServices
2
,CHAPTERf1
ANf INTRODUCTIONf TOf ASSURANCEf ANDf FINANCIALf STATEMENTf AUDITING
AnswersftofReviewfQuestions
1-1 Thefstudyfoffauditingfisfmorefconceptualfinfnaturefcomparedftofotherfaccountingfcourses.fR
atherfthanffocusingfonflearningfthefrules,ftechniques,fandfcomputationsfrequiredftofprepareffinancia
lfstatements,fauditingfemphasizesflearningfafframeworkfoffanalyticalfandflogicalfskillsftofevaluatefthef
relevancefandfreliabilityfoffthefsystemsfandfprocessesfresponsiblefforffinancialfinformation,fasfwellf
asfthefinformationfitself.fTofbefsuccessful,fstudentsfmustflearnfthefframeworkfandfthenflearnftofusefl
ogicfandfcommonfsensefinfapplyingfauditingfconceptsftofvariousfcircumstancesf andfsituations.
Understandingfauditingfcanfimprovefthefdecisionfmakingfabilityfoffconsultants,fbusinessfma
nagers,fandfaccountantsfbyfprovidingfafframeworkfforfevaluatingfthefusefulnessfandfreliabil
ityfoffinformation.
1-2 Therefisfafdemandfforfauditingfinfaffree-
marketfeconomyfbecausefthefagencyfrelationshipfbetweenfanfabsenteefownerfandfafmanagerfpro
ducesfafnaturalfconflictfoffinterestfdueftofthefinformationfasymmetryfthatfexistsfbetweenfthefownerf
andfmanager.fAsfafresult,fthefagentfagreesftofbefmonitoredfasfpartfoffhis/herfemploymentfcontract.f
Auditingfappearsftofbefafcost-effectivefformfoffmonitoring.
Thefempiricalfevidencefsuggestsfauditingfwasfdemandedfpriorftofgovernmentfregulationfsuc
hfasfstatutoryfauditfrequirements.fAdditionally,fmanyfprivatefcompaniesfandfotherfentitiesfnotfsubje
ctftofgovernmentfauditingfregulationsfalsofdemandfauditing.
1-3 Thefagencyfrelationshipfbetweenfanfownerfandfmanagerfproducesfafnaturalfconflictfoffinte
restfbecausefoffdifferencesfinftheftwofparties’fgoalsfandfbecausefoffinformationfasymmetryfthatfexi
stsfbetweenfthem.fThatfis,fthefmanagerfgenerallyfhasfmorefinformationfaboutfthef‘true’ffinancialfpo
sitionfandfresultsfoffoperationsfoffthefentityfthanfthefabsenteefownerfdoes.fIffbothfpartiesfseekftofm
aximizeftheirfownfself-
interest,fitfisflikelyfthatfthefmanagerfwillfnotfactfinfthefbestfinterestfoffthefownerfandfmayfmanipulateft
hefinformationfprovidedftofthefownerfaccordingly.
1-4 Independencefisfanfimportantfstandardfforfauditors.fIffanfauditorfisfnotfindependentfoffthefc
lient,fusersfmayflosefconfidencefinfthefauditor’sfabilityftofreportftruthfullyfonftheffinancialfstatements
,fandfthefauditor’sfworkflosesfitsfvalue.fFromfanfagencyfperspective,fiffthefprincipalf(owner)fknowsft
hatfthefauditorfisfnotfindependent,fthefownerfwillfnotftrustfthefauditor’sfwork.
Thus,fthefagentfwillfnotfhirefthefauditorfbecausefthefauditor’sfreportfwillfnotfbefeffectivefinfreducingfinf
ormationfriskffromfthefperspectivefoffthefowner.
1-5 Auditingf(broadlyfdefined)fisfafsystematicfprocessfoffobjectivelyfobtainingfandfevaluatin
gfevidencefregardingfassertionsfaboutfeconomicfactionsfandfeventsftofascertainfthefdegreefoffcor
respondencefbetweenfthosefassertionsfandfestablishedfcriteriafandfcommunicatingfthefresultsft
ofinterestedf users.
Assurancefisfengagementfinfwhichfafpractitionerfexpressesfafconclusionfdesignedftofenha
ncefthefdegreefoffconfidencefoffthefintendedfusersfotherfthanfthefresponsiblefpartyfaboutfthefoutcom
efoffthefevaluationforfmeasurementfoffafsubjectfmatterfagainstfcriteria.
Examplesfoffassurancefservicesfarefassurancef(audit)fofffinancialfstatements,fassurancefo
ffprospectiveffinancialfinformation,fassurancefoffreportingfonfinternalfcontrol,fassurancefoffsustaina
bilityfreporting,fandfassurancefoffelectronicfcommerce.
3
, 1-6 Thefphrasefsystematicfprocessfimpliesfthatftherefshouldfbefafwell-
planned,flogicalfapproachfforfconductingfanfauditfthatfinvolvesfobjectivelyfobtainingfandfevaluati
ngfevidence.
1-7 Materiality:f"Omissionsforfmisstatementsfoffitemsfarefmaterialfifftheyfcould,findividuallyforfc
ollectively,finfluencefthefeconomicfdecisionsfoffusersftakenfonfthefbasisfofftheffinancialfstatements.f
Materialityfdependsfonfthefsizefandfnaturefoffthefomissionforfmisstatementfjudgedfinfthefsurroundin
gfcircumstances.fThefsizeforfnaturefoffthefitem,forfafcombinationfoffboth,fcouldfbefthef determiningffac
tor."f(IASB).
Auditfriskfisfdefinedfasfthefriskfthatfthefauditorfexpressesfanfinappropriatefauditfopinionfwhe
nftheffinancialfstatementsfarefmateriallyf misstatedf(ISAf200).
Thefauditfreportfstatesfthatfthefauditorfobtainsf“reasonablefassurance”fwhetherftheffinancia
lfstatementsfareffreeffromf“material”fmisstatement.fTheftermfreasonablefassurancefinformsfthefrea
derfthatftherefisfsomeflevelfoffriskfthatfthefauditfdidfnotfdetectfallfmaterialfmisstatements.fInfaddition,f
thefauditor’sfopinionfcommonlyfusesfthefwordingfthatftheffinancialfstatementsfpresentffairly,f“infallfm
aterialfrespects.”fThesefphrasesfcommunicateftofthirdfpartiesfthatfthefauditfreportfisflimitedftofmateri
alfinformation.
1-8 Onfmostfaudits,fitfisfnotffeasibleforfcost-
effectiveftofauditfallftransactions.fForfexample,finfafsmallfbusiness,fthefauditorfmightfbefableftofexam
inefallftransactionsfthatfoccurredfduringfthefperiod.fHowever,fitfisfunlikelyfthatfthefownerfoffthefbusin
essfcouldfaffordftofpayfforfsuchfanfextensivefaudit.fForfaflargeforganization,fthefsheerfvolumefofftran
sactionsfpreventsfthefauditorffromfexaminingfeveryftransaction.fThus,ftherefisfaftrade-
offfbetweenfthefexactnessforfprecisionfoffthefauditfandfitsfcost.
1-9 Thefmajorfphasesfoffthefauditfare:
• Clientf acceptance/continuancef andf establishingf engagementf terms
• Preplanning
• Assessfrisksfandfestablishfmateriality
• Planfthefaudit
• Considerfinternalfcontrol
• Auditfbusinessfprocessesfandfrelatedfaccounts
• Completefthefaudit
• Evaluatefresultsfandfissuefauditfreport
1-10 Thefauditor’sfunderstandingfoffthefentityfandfitsfenvironmentfincludesfknowledgefabo
ut:f(1)fthefnaturefoffthefentity,f(2)fitsfobjectivesfandfstrategies,f(3)fitsfindustry,fregulatory,fandfothe
rfexternalffactors,f(4)fitsfmanagement,f(5)fitsfgovernance,f(6)fitsfmeasurementfandfperformancef
process,fandf(7)fitsfbusinessf processes.
1-11 Sometimesfauditorsfwillffacefsituationsfwherefnofstandardfauditfprocedurefexists,fsuchfasft
hefexampleffromftheftextfoffverifyingfthefinventoryfoffreindeer.fSuchfcircumstancesfrequirefthatfthef
auditorfpossessfcreativityfandfinnovationfwhenfplanningfandfadministeringfauditfproceduresfwher
eflittleforfnofprecedentfexists.fEveryfclientfisfdifferent,fandfapplyingfauditingfconceptsfinfdifferentfsit
uationsfrequiresflogicfandfcommonfsense,fandffrequentlyfcreativityfandfinnovation.
SolutionsftofProblems
1-12 Thefmemofshouldfciteftheffollowingffacts:
• Therefisfafhistoricalfrelationshipfbetweenfaccountingfandfauditing.
4
