1
,• TableofContents
Chapter1:AnIntroductiontoAssuranceandFinancialStatementAuditing
V
Chapter2:TheFinancialStatementAuditing Environment
n n V
n Chapter3:AuditPlanning,TypesofAuditTests,andMateriality V V
Chapter4:RiskAssessment
n V
Chapter5:EvidenceandDocumentation
Chapter6:InternalControlinaFinancialStatementAudit
n n V n
n Chapter7:AuditingInternalControloverFinancialReporting
n Chapter8:AuditSampling:AnOverviewandApplicationtoTestsofControls
V n n
n Chapter9:AuditSampling:AnApplicationt oSubstantiveTestsofAccountBalances
V V n
Chapter10:AuditingtheRevenueProcess
n n
n Chapter11:AuditingfthePurchasingProcess V
Chapter12:AuditingtheHumanResourceManagementProcess n V V
Chapter13:AuditingtheInventoryManagementProcess
n
Chapter14:AuditingtheFinancing/InvestingProcess:PrepaidExpenses,IntangibleAssets,andProperty,Plant,andEquipment
V V V V
Chapter15:AuditingtheFinancing/InvestingProcess:Long-
n V
TermLiabilities,Stockholders’Equity,andIncomeStatementAccounts
n V
Chapter16:AuditingtheFinancing/InvestingProcess:CashandI nvestments V V n
Chapter17:CompletingthefAuditEngagement
n n
Chapter18:ReportsonAuditedFinancialStatements
n V
n Chapter19:ProfessionalConduct,Independence,andQualityManagement V V
Chapter20:LegalLiability
n
n Chapter21:Assurance,Attestation,andInternalAuditingServices V V
2
,CHAPTERf1
ANINTRODUCTIONTOASSURANCE ANDFINANCIALSTATEMENTAUDITING
n n n n n n
AnswerstoReviewQuestions
1-1 Thestudyofauditingismoreconceptualinnaturecomparedtootheraccountingcourses.Rather V V
thanfocusingonlearningtherules,techniques,andcomputationsrequiredtopreparefinancia
n n
lstatements,auditingemphasizeslearningaframeworkofanalyticalandlogicalskillstoevaluatethe
n n n
relevanceandreliabilityofthesystemsandprocessesresponsiblef orfinancialinformation,aswell
n V V n n V
astheinformationitself.Tobesuccessful,studentsmustlearntheframeworkandthenlearntousefl
n n n V n
ogic andcommonsenseinapplyingauditingconceptsto various circumstancesandsituations.
n n V n n
n Understanding auditing canimprovethedecision making ability ofconsultants, businessma n n n n n n n
nagers, and accountants by providing a frameworkfor evaluating the usefulness andreliabil
n n n n n n n n n n n n
ityofinformation.
n
1-2 Thereisademandforauditinginafree-
marketeconomybecausetheagencyrelationshipbetweenanabsenteeownerandamanagerproducesa
V n
naturalconflict ofinterestfduetotheinformationasymmetrythatexistsbetweentheownerandmanager.
n V n
Asaresult,theagentagreestobemonitoredasfpartofhis/heremploymentfcontract.Auditingappearsto n
beacost-effectiveformofmonitoring.
n n
Theempiricalevidence suggestsauditingwas demandedprior togovernmentregulationsuc h as n n n n n n n n
statutory auditfrequirements. Additionally, many private companies and other entities not subje
n n n n n n n n n n n
ctftogovernmentauditingregulationsalsodemandauditing.
n
1-3 The agency relationship between an owner and manager produces a natural conflict ofinte rest
n n n n n n n n n n n n n
because of differences in the two parties‘ goals and because of informationasymmetrythatfexi sts
n n n n n n n n n n n n n
between them. That is, the manager generally has more information aboutfthe ‗true‘financial po sition
n n n n n n n n n n n n n n
andresults ofoperationsofthefentitythantheabsenteeownerdoes.Ifbothpartiesseektom aximizetheir
n n V n
ownself-
n
interest, itfisflikely thatfthe manager will not act in the best interest of the owner and may manipulate t
n n n n n n n n n n n n n n n n n
heinformationprovidedtotheowneraccordingly.
n
1-4 Independenceisfanimportantfstandardforauditors.Ifanauditorisnotindependentoftheclient, V V
nusersmayloseconfidenceintheauditor‘sabilitytoreport truthfullyonthefinancialstatements
n V
,andtheauditor‘sworkflosesitsvalue.Fromanagencyperspective,iftheprincipal(owner)knowst V n
hattheauditorisnot independent,theownerwillnottrustt he auditor‘swork.
n n n V n n
Thus,theagentwillnothiretheauditorbecausetheauditor‘sreportfwillnotbeeffectiveinreducinginf n n n n
ormationriskffromtheperspectiveoftheowner.
n n
1-5 Auditing (broadly defined) is a systematic process of objectively obtaining and evaluatin
n n n n n n n n n n n
gevidence regarding assertions aboutfeconomic actionsfand eventstoascertain thedegree of cor
n n n n n n n n n
respondence between those assertions and established criteria and communicating the results t
n n n n n n n n n n n n
ointerestedusers.
n
Assurance is engagement in which a practitioner expresses a conclusion designed to enha n n n n n n n n n n n n
ncethedegreeofconfidence of theintended users other thantheresponsible party aboutthe outcom
n n n n n n n n n
eoftheevaluationormeasurement ofasubjectmatteragainstfcriteria.
n V n V
Examples of assurance services are assurance (audit) of financial statements, assurance o f
n n n n n n n n n n n n
prospective financial information, assurance of reporting oninternal control,assurance of sustaina bility
n n n n n n n n n n n
reporting,andassuranceofelectronicfcommerce.
n
3
, 1-6 Thephrasesystematicprocessimpliesfthatfthereshouldbeawell- n n n n n
planned,logicalapproachforconductinganauditfthati nvolvesobjectivelyfobtainingfandevaluati V n
ngevidence.n
1-7 Materiality: "Omissions or misstatements of items are material if they could, individuallyor c n n n n n n n n n n n n
ollectively, influence the economic decisions of users taken on the basis of the financial statements.
n n n n n n n n n n n n n n n
Materiality depends on the size and nature of the omission or misstatement judged inthesurroundin g
n n n n n n n n n n n n n n n
circumstances. The size or nature of theitem, oracombination of both, couldbefthe determining fac
n n n n n n n n n n n n n
tor."(IASB).
n
Audit risk isfdefined asthe risk that the auditor expresses aninappropriate auditfopinionwhe
n n n n n n n n n n
nthefinancialstatementsaremateriallymisstated(ISA200).
n n V
The audit reportfstates that the auditor obtains ―reasonable assurance‖ whether the financia l
n n n n n n n n n n n n
statements are free from “material” misstatement. The term reasonable assurance informs the rea der that
n n n n n n n n n n n n n n n
there is some level of riskfthatfthe auditfdid notfdetect all material misstatements. In addition, the auditor‘s
n n n n n n n n n n n n n n n
opinion commonly uses the wording thatfthe financial statements present fairly, ―inall m aterial respects.‖
n n n n n n n n n n n n n n
These phrases communicate tothird partiesthat the audit reportfis limited to materi alinformation.
n n n n n n n n n n n n n
1-8 Onmostaudits,iti snotffeasibleorcost- V V n n
effectivetoauditalltransactions.Forexample,inasmallbusiness,theauditormightbeabletoexamineall
n V V V n
transactionsthatoccurredduringtheperiod.However,itisunlikelythattheownerofthebusinesscould
n n V
affordtopayforsuchanextensiveaudit.Foralargeorganization,thesheervolumeoftran
n n
sactionspreventstheauditorfromexaminingeverytransaction.Thus,thereisatrade-
n V n
noffbetweentheexactnessorprecisionoftheauditfanditscost. V n
1-9 Themajorphasesoftheauditare: n
• Clientacceptance/continuanceandestablishingengagementf terms n V n
• Preplanning
• Assessrisksandestablishmateriality n
• Planthefaudit
• Considerinternalcontrol
• Auditbusinessprocessesandrelatedaccounts V
• Completet heaudit V n n
• Evaluateresultsandissueauditr eport V n
1-10 The auditor‘sfunderstanding of the entity and itsenvironmentfincludesknowledge abo ut:
n n n n n n n n n n
(1) thenature of theentity, (2) itsobjectives and strategies, (3) its industry, regulatory,and othe r
n n n n n n n n n n n n n
external factors, (4) its management, (5) its governance, (6) its measurement and performance
n n n n n n n n n n n n n
process,and(7)itsbusinessprocesses.
n n
1-11 Sometimes auditors will face situations wherenostandard audit procedureexists, suchas t he n n n n n n n n n n
examplefrom the text of verifying the inventory ofreindeer. Such circumstances require thatthe auditor
n n n V n n n n n n n n n n
possessfcreativity andinnovation when planning and administering audit procedures wher elittleorno
n n n n n n n n n n
precedent exists. Every clientfis different, and applying auditing concepts in differentfsit
n n n n n n n n n n n
uations requireslogicandcommonsense,andfrequentlycreativityandinnovation.
n n
SolutionstoProblems
1-12 Thememoshouldcitethefollowingfacts:
• Thereisahistoricalrelationship betweenaccountingandauditing. n
4
,• TableofContents
Chapter1:AnIntroductiontoAssuranceandFinancialStatementAuditing
V
Chapter2:TheFinancialStatementAuditing Environment
n n V
n Chapter3:AuditPlanning,TypesofAuditTests,andMateriality V V
Chapter4:RiskAssessment
n V
Chapter5:EvidenceandDocumentation
Chapter6:InternalControlinaFinancialStatementAudit
n n V n
n Chapter7:AuditingInternalControloverFinancialReporting
n Chapter8:AuditSampling:AnOverviewandApplicationtoTestsofControls
V n n
n Chapter9:AuditSampling:AnApplicationt oSubstantiveTestsofAccountBalances
V V n
Chapter10:AuditingtheRevenueProcess
n n
n Chapter11:AuditingfthePurchasingProcess V
Chapter12:AuditingtheHumanResourceManagementProcess n V V
Chapter13:AuditingtheInventoryManagementProcess
n
Chapter14:AuditingtheFinancing/InvestingProcess:PrepaidExpenses,IntangibleAssets,andProperty,Plant,andEquipment
V V V V
Chapter15:AuditingtheFinancing/InvestingProcess:Long-
n V
TermLiabilities,Stockholders’Equity,andIncomeStatementAccounts
n V
Chapter16:AuditingtheFinancing/InvestingProcess:CashandI nvestments V V n
Chapter17:CompletingthefAuditEngagement
n n
Chapter18:ReportsonAuditedFinancialStatements
n V
n Chapter19:ProfessionalConduct,Independence,andQualityManagement V V
Chapter20:LegalLiability
n
n Chapter21:Assurance,Attestation,andInternalAuditingServices V V
2
,CHAPTERf1
ANINTRODUCTIONTOASSURANCE ANDFINANCIALSTATEMENTAUDITING
n n n n n n
AnswerstoReviewQuestions
1-1 Thestudyofauditingismoreconceptualinnaturecomparedtootheraccountingcourses.Rather V V
thanfocusingonlearningtherules,techniques,andcomputationsrequiredtopreparefinancia
n n
lstatements,auditingemphasizeslearningaframeworkofanalyticalandlogicalskillstoevaluatethe
n n n
relevanceandreliabilityofthesystemsandprocessesresponsiblef orfinancialinformation,aswell
n V V n n V
astheinformationitself.Tobesuccessful,studentsmustlearntheframeworkandthenlearntousefl
n n n V n
ogic andcommonsenseinapplyingauditingconceptsto various circumstancesandsituations.
n n V n n
n Understanding auditing canimprovethedecision making ability ofconsultants, businessma n n n n n n n
nagers, and accountants by providing a frameworkfor evaluating the usefulness andreliabil
n n n n n n n n n n n n
ityofinformation.
n
1-2 Thereisademandforauditinginafree-
marketeconomybecausetheagencyrelationshipbetweenanabsenteeownerandamanagerproducesa
V n
naturalconflict ofinterestfduetotheinformationasymmetrythatexistsbetweentheownerandmanager.
n V n
Asaresult,theagentagreestobemonitoredasfpartofhis/heremploymentfcontract.Auditingappearsto n
beacost-effectiveformofmonitoring.
n n
Theempiricalevidence suggestsauditingwas demandedprior togovernmentregulationsuc h as n n n n n n n n
statutory auditfrequirements. Additionally, many private companies and other entities not subje
n n n n n n n n n n n
ctftogovernmentauditingregulationsalsodemandauditing.
n
1-3 The agency relationship between an owner and manager produces a natural conflict ofinte rest
n n n n n n n n n n n n n
because of differences in the two parties‘ goals and because of informationasymmetrythatfexi sts
n n n n n n n n n n n n n
between them. That is, the manager generally has more information aboutfthe ‗true‘financial po sition
n n n n n n n n n n n n n n
andresults ofoperationsofthefentitythantheabsenteeownerdoes.Ifbothpartiesseektom aximizetheir
n n V n
ownself-
n
interest, itfisflikely thatfthe manager will not act in the best interest of the owner and may manipulate t
n n n n n n n n n n n n n n n n n
heinformationprovidedtotheowneraccordingly.
n
1-4 Independenceisfanimportantfstandardforauditors.Ifanauditorisnotindependentoftheclient, V V
nusersmayloseconfidenceintheauditor‘sabilitytoreport truthfullyonthefinancialstatements
n V
,andtheauditor‘sworkflosesitsvalue.Fromanagencyperspective,iftheprincipal(owner)knowst V n
hattheauditorisnot independent,theownerwillnottrustt he auditor‘swork.
n n n V n n
Thus,theagentwillnothiretheauditorbecausetheauditor‘sreportfwillnotbeeffectiveinreducinginf n n n n
ormationriskffromtheperspectiveoftheowner.
n n
1-5 Auditing (broadly defined) is a systematic process of objectively obtaining and evaluatin
n n n n n n n n n n n
gevidence regarding assertions aboutfeconomic actionsfand eventstoascertain thedegree of cor
n n n n n n n n n
respondence between those assertions and established criteria and communicating the results t
n n n n n n n n n n n n
ointerestedusers.
n
Assurance is engagement in which a practitioner expresses a conclusion designed to enha n n n n n n n n n n n n
ncethedegreeofconfidence of theintended users other thantheresponsible party aboutthe outcom
n n n n n n n n n
eoftheevaluationormeasurement ofasubjectmatteragainstfcriteria.
n V n V
Examples of assurance services are assurance (audit) of financial statements, assurance o f
n n n n n n n n n n n n
prospective financial information, assurance of reporting oninternal control,assurance of sustaina bility
n n n n n n n n n n n
reporting,andassuranceofelectronicfcommerce.
n
3
, 1-6 Thephrasesystematicprocessimpliesfthatfthereshouldbeawell- n n n n n
planned,logicalapproachforconductinganauditfthati nvolvesobjectivelyfobtainingfandevaluati V n
ngevidence.n
1-7 Materiality: "Omissions or misstatements of items are material if they could, individuallyor c n n n n n n n n n n n n
ollectively, influence the economic decisions of users taken on the basis of the financial statements.
n n n n n n n n n n n n n n n
Materiality depends on the size and nature of the omission or misstatement judged inthesurroundin g
n n n n n n n n n n n n n n n
circumstances. The size or nature of theitem, oracombination of both, couldbefthe determining fac
n n n n n n n n n n n n n
tor."(IASB).
n
Audit risk isfdefined asthe risk that the auditor expresses aninappropriate auditfopinionwhe
n n n n n n n n n n
nthefinancialstatementsaremateriallymisstated(ISA200).
n n V
The audit reportfstates that the auditor obtains ―reasonable assurance‖ whether the financia l
n n n n n n n n n n n n
statements are free from “material” misstatement. The term reasonable assurance informs the rea der that
n n n n n n n n n n n n n n n
there is some level of riskfthatfthe auditfdid notfdetect all material misstatements. In addition, the auditor‘s
n n n n n n n n n n n n n n n
opinion commonly uses the wording thatfthe financial statements present fairly, ―inall m aterial respects.‖
n n n n n n n n n n n n n n
These phrases communicate tothird partiesthat the audit reportfis limited to materi alinformation.
n n n n n n n n n n n n n
1-8 Onmostaudits,iti snotffeasibleorcost- V V n n
effectivetoauditalltransactions.Forexample,inasmallbusiness,theauditormightbeabletoexamineall
n V V V n
transactionsthatoccurredduringtheperiod.However,itisunlikelythattheownerofthebusinesscould
n n V
affordtopayforsuchanextensiveaudit.Foralargeorganization,thesheervolumeoftran
n n
sactionspreventstheauditorfromexaminingeverytransaction.Thus,thereisatrade-
n V n
noffbetweentheexactnessorprecisionoftheauditfanditscost. V n
1-9 Themajorphasesoftheauditare: n
• Clientacceptance/continuanceandestablishingengagementf terms n V n
• Preplanning
• Assessrisksandestablishmateriality n
• Planthefaudit
• Considerinternalcontrol
• Auditbusinessprocessesandrelatedaccounts V
• Completet heaudit V n n
• Evaluateresultsandissueauditr eport V n
1-10 The auditor‘sfunderstanding of the entity and itsenvironmentfincludesknowledge abo ut:
n n n n n n n n n n
(1) thenature of theentity, (2) itsobjectives and strategies, (3) its industry, regulatory,and othe r
n n n n n n n n n n n n n
external factors, (4) its management, (5) its governance, (6) its measurement and performance
n n n n n n n n n n n n n
process,and(7)itsbusinessprocesses.
n n
1-11 Sometimes auditors will face situations wherenostandard audit procedureexists, suchas t he n n n n n n n n n n
examplefrom the text of verifying the inventory ofreindeer. Such circumstances require thatthe auditor
n n n V n n n n n n n n n n
possessfcreativity andinnovation when planning and administering audit procedures wher elittleorno
n n n n n n n n n n
precedent exists. Every clientfis different, and applying auditing concepts in differentfsit
n n n n n n n n n n n
uations requireslogicandcommonsense,andfrequentlycreativityandinnovation.
n n
SolutionstoProblems
1-12 Thememoshouldcitethefollowingfacts:
• Thereisahistoricalrelationship betweenaccountingandauditing. n
4
