Auditing & Assurance Services Auditing & Assurance Services Timothy J Louwers, PhD, CPA, CISA, CFF Director of the School of Accounting and KPMG Eminent Professor in Accounting Allen D Blay, PhD, CPA Associate Professor of Accounting Florida State University David H Sinason, PhD, CPA, CIA, CFE, CFSA, CRMA PwC Professor of Accountancy Northern Illinois University Jerry R Strawser, PhD, CPA KPMG Chair of Accounting Texas A&M University Jay C Thibodeau, PhD, CPA Rae D Anderson Professor of Accounting Bentley University AUDITING & ASSURANCE SERVICES, SEVENTH EDITION Published by McGraw-Hill Education, Penn Plaza, New York, NY 10121 Copyright 2018 by McGraw-Hill Education All rights reserved Printed in the United States of America Previous editions 2015, 2013, and 2011 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper LWI 21 20 19 18 17 ISBN 978-1-259-57328-6 MHID 1-259-57328-1 Chief Product Officer, SVP Products & Markets:  G Scott Virkler Vice President Portfolio & Learning Content:  Michael Ryan Managing Director:  Tim Vertovec Marketing Director:  Natalie King Brand Manager:  Patricia Plumb Director, Product Development:  Rose Koos Associate Director of Digital Content:  Kevin Moran Lead Product Developers:  Michele Janicek / Kristine Tibbetts Senior Product Developer:  Rebecca Mann Product Developer:  Randall Edwards Marketing Manager:  Cheryl Osgood Digital Product Analyst:  Xin Lin Director, Content Design & Delivery:  Linda Avenarius Program Manager:  Daryl Horrocks Senior Content Project Managers:  Dana M Pauley / Angela Norris Buyer:  Laura M Fuller Design:  Matt Diamond Content Licensing Specialists:  Shawntel Schmitt / Lori Slattery Cover Image:  The-Lightwrighter/Getty Images Compositor:  SPi Global Printer:  LSC Communications All credits appearing on page or at the end of the book are considered to be an extension of the copyright page Library of Congress Cataloging-in-Publication Data Names: Louwers, Timothy J., author Title: Auditing & assurance services / Timothy J Louwers, James Madison University, David H Sinason, Northern Illinois University, Jerry R Strawser, Texas A&M University, Jay C Thibodeau, Bentley College, Allen D Blay Other titles: Auditing and assurance services Description: Seventh edition | New York, NY: McGraw-Hill Education, [2018] Identifiers: LCCN 2016042220 | ISBN 9781259573286 (alk paper) Subjects: LCSH: Auditing Classification: LCC HF5667 A815 2018 | DDC 657/.45—dc23 LC record available at https://lccn.loc.gov/2016042220 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites mheducation.com/highered Some people come into our lives and quickly go Some stay awhile and leave footprints on our hearts and we are never quite the same Anonymous We dedicate this book to the following educators whose footprints we try to follow: Professor Homer Bates (University of North Florida) Professor Stanley Biggs (University of Connecticut) Professor Lewis C Buller (Indiana State University) Professor Patrick Delaney (Northern Illinois University) Professor William Hillison (Florida State University) Professor John Ivancevich (University of Houston) Professor Richard Kochanek (University of Connecticut) Professor John L “Jack” Kramer (University of Florida) Professor Jack Robertson (University of Texas at Austin) Professor Robert Strawser (Texas A&M University) Professor Sally Webber (Northern Illinois University) Professor “IBM Jim” Whitney (The Citadel) Meet the Authors Timothy J Louwers  Courtesy James Madison University is the Director of the School of Accounting and KPMG Eminent Professor in Accounting at James Madison University Professor Louwers received his undergraduate and master’s degrees from The Citadel and his PhD from Florida State University Prior to beginning his academic career, he worked in public accounting with KPMG, specializing in financial, governmental, and information systems auditing He is a certified public accountant (South Carolina and Virginia) and a certified information systems auditor He is also certified in financial forensics Professor Louwers’s research interests include auditors’ reporting decisions and ethical issues in the accounting profession He has authored or coauthored more than 60 publications on a wide range of accounting, auditing, and technology-related topics, including articles in the Journal of Accounting Research, Accounting Horizons, the Journal of Business Ethics, Behavioral Research in Accounting, Decision Sciences, the Journal of Forensic Accounting, Issues in Accounting Education, the Journal of Accountancy, the CPA Journal, and Today’s CPA Some of his published work has been reprinted in Russian and Chinese He is a respected lecturer on auditing and technology-related issues and has received teaching excellence awards from the University of Houston and Louisiana State University He has appeared on both local and national television news broadcasts, including MSNBC and CNN news programs Allen D Blay  Courtesy Kallen M Lunt is an Associate Professor of Accounting at Florida State University Professor Blay completed his PhD at the University of Florida in 2000 He teaches auditing at all levels and teaches a seminar in auditing research in the doctoral program His research interests relate to auditor judgment and decision making Professor Blay has authored or coauthored publications on a wide range of accounting and auditing topics in journals such as Contemporary Accounting Research, Auditing: A Journal of Practice and Theory, Organizational Behavior and Human Decision Processes, the Journal of Business Ethics, Behavioral Research in Accounting, Issues in Accounting Education, the International Journal of Auditing, and the Journal of Accounting, Auditing, and Finance He is currently Associate Editor for Issues in Accounting Education and serves on several editorial boards Professor Blay has been active in the American Accounting Association, serving on the auditing education committee and the annual meeting committee as Accounting, Behavior, and Organizations section chair, among other committees He is also active in the American Institute of CPAs, serving in various volunteer roles relating to the Uniform CPA Exam Prior to entering academics, Professor Blay worked in public accounting auditing financial institutions He currently directs the accounting doctoral program at Florida State University David H Sinason  Courtesy Northern Illinois University vi is the PwC Professor of Accountancy at Northern Illinois University (NIU) and director of the NIU Internal Audit program Professor Sinason received a BS in engineering from the University of Illinois, a BS in History from Northern Illinois University, a BBA and MAcc in accounting from the University of North Florida, and a PhD in accounting from Florida State University He has certifications as a certified public accountant, a certified internal auditor, a certified financial services auditor, and a certified fraud examiner He also has certification in risk management assurance Professor Sinason has written more than 50 articles, mostly in the areas of assurance services, fraud prevention and detection, and auditor liability Meet the Authors vii Professor Sinason has taught in the areas of accounting information systems, auditing and assurance services, and financial accounting He has received teaching awards at each of the universities where he has taught including the 2002–2003 Department of Accountancy and Northern Illinois University Awards for Excellence in Undergraduate Teaching Jerry R Strawser  Courtesy Jerry R Strawser is Executive Vice President and Chief Financial Officer at Texas A&M University and holds the KPMG Chair in Accounting Prior to his current appointment, Professor Strawser served as dean of Mays Business School at Texas A&M University, interim executive vice president and provost at Texas A&M University, interim dean of the C T Bauer College of Business at the University of Houston, and Arthur Andersen & Co Alumni Professor of Accounting Professor Strawser has coauthored three textbooks and more than 60 journal articles In addition to his academic experience, he had prior public accounting experience at two Big Five accounting firms He has also developed and delivered numerous executive development programs to organizations such as AT&T, Centerpoint Energy, Continental Airlines, ConocoPhillips, Halliburton, KBR, KPMG, Minute Maid, PricewaterhouseCoopers, McDermott International, Shell, Southwest Bank of Texas, and the Texas Society of Certified Public Accountants Professor Strawser is a certified public accountant in the state of Texas and earned his BBA and PhD in Accounting from Texas A&M University Jay C Thibodeau  Courtesy Bentley University is the Rae D Anderson Professor of Accounting at Bentley University Professor Thibodeau is a certified public accountant and a former auditor He received his bachelor’s degree from the University of Connecticut in 1987 and his PhD from the University of Connecticut in 1996 He joined the faculty at Bentley in 1996 and has remained there At Bentley, he serves as the coordinator for all audit and assurance curriculum matters His off-campus commitments include consulting with the Audit Learning and Development group at KPMG Professor Thibodeau’s scholarship focuses on audit judgment and decision making and audit education He is a coauthor of two textbooks and has written more than 40 book chapters and articles for academics and practitioners in journals such as Auditing: A Journal of Practice & Theory, Accounting Horizons, and Issues in Accounting Education Professor Thibodeau served as the President of the Auditing Section of the American Accounting Association for the 2014/2015 academic year He served on the Executive Committee for the Auditing Section from 2008 to 2010 He has received national recognition for his work five times First, for his thesis, winning the 1996 Outstanding Doctoral Dissertation Award presented by the ABO section of the AAA Three other times, for curriculum innovation, winning the 2001 Joint AICPA/AAA Collaboration Award, the 2003 Innovation in Assurance Education Award, and the 2016 Forensic Accounting Teaching Innovation Award Finally, for outstanding service, receiving a Special Service Award from the Auditing Section for his work in helping to create the “Access to Auditors” program sponsored by the Center for Audit Quality Look Beneath the Surface  .  As auditors, we are trained to investigate beyond appearances to determine the underlying facts—in other words, to look beneath the surface From the Enron and WorldCom scandals of the early 2000s to the financial crisis of 2007–2008 to present-day issues and challenges related to significant estimation uncertainty, understanding the auditor’s responsibility related to fraud, maintaining a clear perspective, probing for details, and understanding the big picture are indispensable to effective auditing With the availability of greater levels of qualitative and quantitative information (“big data”), the need for technical skills and challenges facing today’s auditor is greater than ever The author team of Louwers, Blay, Sinason, Strawser, and Thibodeau has dedicated years of experience in the auditing field to this new edition of Auditing & Assurance Services, supplying the necessary investigative tools for future auditors Cutting-Edge Coverage The seventh edition of Auditing & Assurance Services continues its tradition as the most up-to-date auditing text on the market All chapters and modules have been revised to incorporate the latest professional standards, recodifications, and proposals from the International Auditing and Assurance Standards Board, Auditing Standards Board, and Public Company Accounting Oversight Board To acquaint students with the professional standards, each chapter or module begins with a list of the relevant professional standards that are covered in that chapter Importantly, this text incorporates the reorganized PCAOB standards effective December 31, 2016 As a team, we use a variety of contacts and resources to stay informed of ongoing developments that affect learning objectives in the financial statement auditing course(s) In fact, changes to key learning goals and objectives are usually prompted by interactions with colleagues from practice In that spirit, since the publication of our sixth edition, we have been working hard to stay in touch with developments in practice so we can always respond to your needs in the financial statement auditing classroom Among our many observations, one trend has emerged as a potential sea change in the financial statement auditing process, the “big data” challenge Indeed, based on our collective observations, we believe that students should be prepared to make the best use possible of relevant data using state-of-the art analytical tools In fact, the terms big data and data analytics are frequently being used to describe a growing movement among audit professionals Our collective view is that students must be prepared to meet the “big data” challenge To help students be prepared, the seventh edition of Auditing & Assurance Services has been revised deliberately to help students critically think about the use of increased data and analytical tools in the financial statement audit In addition, we would like to help students learn how to effectively document their conclusions in the current “big data” environment In a recent white paper, PwC (2015)1 lists five “new” skills that will be required of auditors moving forward Although many of these skills require special statistical or programming knowledge, the first listed skill is one that is applicable to all auditors: “Research and identify anomalies and risk factors in underlying data.” Although “Data Driven: What Students Need to Succeed in a Rapidly Changing Business World.” Available at: http://www.pwc.com/us/en/faculty-resource/assets/PwC-Data-driven-paper-Feb2015.pdf viii extraction and analysis from client accounting data are critical skills for newly minted auditors, we are unaware of sufficient materials to assist professors in integrating data analytics into the auditing classroom Thus, an important goal of the seventh edition is to provide a clear and implementable method to fully integrate a leading data analysis tool, the IDEA data analysis software, into the auditing class To start, McGraw-Hill Education is excited to announce a partnership with the developers of the IDEA software We believe that IDEA provides an outstanding platform to illustrate the steps that auditors need to take related to data and data analysis while completing the financial statement audit Leading auditing professionals have confirmed that using IDEA is an outstanding way for an entry-level auditing professional to begin the journey into the world of “big data” and “data analytics.” Simply stated, big data is manifested in the financial statement auditing process through the use of tools like IDEA Overall, our revisions related to the big data challenge were designed to provide instructors a set of tools and mechanisms to bring data and analytics into the classroom in a meaningful way Through the use of these tools, students can be sure they are prepared to enter practice with an appreciation for and knowledge of the increasing importance of data and analytics in the auditing profession We hope that everyone enjoys our attempts to help students get ready for the big data challenge Of course, and perhaps most importantly, the seventh edition of Auditing & Assurance Services also continues to be the most up-to-date auditing text on the market The book has fully integrated the reorganized PCAOB Auditing Standards In addition, all chapters and modules in the seventh edition have been revised to incorporate the two new standards (AS 2701 and AS 2410) adopted by the PCAOB that relate to the auditor’s work on supplementary information provided in the financial statements and related parties In addition, all chapters and modules have been revised to incorporate the latest updates from the international standards of auditing (ISAs) and the Auditing Standards Board (ASB). With Auditing & Assurance Services, seventh edition, students are prepared to take on auditing’s latest challenges The Louwers author team uses a conversational, yet professional tone­—hailed by reviewers as a key strength of the book Flexible Organization Auditing & Assurance Services teaches students auditing concepts by emphasizing real-life contexts when describing the auditing process The authors use chapters and modules to Chapters The 12 chapters cover the auditing process extensively with a multitude of cases designed to give students a better understanding of how a best-practice concept developed from real-world situations “The format allows you to integrate the modules into the chapter material in any way you would find useful.” —Frank J Beil, University of Minnesota Modules Modules A–H provide instructors additional material that can be used throughout the course Topics such as fraud, ethics, sampling, and technology are covered in the modules, which are designed to be taught whenever instructors want to introduce the topic in their course ix I34  Index Pearson, Michael, 501 Peat, Marwick, Mitchell & company, 689 Peat Marwick, C41 PEEC see Professional Ethics Executive Committee Peer reviews, 41, C38 Pelino, Dennis, 134 Penalties, increased by SOX, 697–698 Pen and paper auditing, C41, C41n Pending order master file, 283–284 Penske Automotive Group, 555 Pentacostalist Assemblies of God, C6 People pressures, managing, 235–236 PeopleSoft, 648 Pepsi-Cola, 229 Peregrine Financial Group Inc., 254 Perei, Steven, 413 Performance audit reports, GAO, 739–741 Performance audits, 26 criteria, 736 GAGAS on, 738 governmental, 735 Performance materiality, 88, 840 determining, 90 Performance measures, 137 Performance principle, 44 audit evidence, 52–53 materiality, 50–51 planning and supervision, 49–50 and quality control, 58 reasonable assurance, 49 in reporting context, 56 risk assessment, 51–52 statement of, 48–49 Performance reviews, 184 Performance standards, 730 Perini Corporation, 234 Periodic inventory counting, 405 Periodic reconciliation acquisition and expenditure cycle, 348–349 of existing assets to recorded amounts, 185 investment accounts, 451 stock ownership, 449 Permanent files composition of, 104–105 definition, 104–105 Permits commissions, 655 Perry, Luke, 413 Perselin, J S., C32n Personnel, payroll department, 382–383 Personnel files, 385 Petrocine, A R., 684n Petty cash count and recount, 257–258 missing, 257–258 Pfeifer, S., 80 Pfizer Inc., 518 Phar-Mor, 395–396, 421–422 Phelps, Martin, 421 Philidor, 501 Physical controls, 185–186 for computer fraud, 906 Physical inventory count, 413 Physical inventory observation audit plan, 441–442 bar codes and computers, 415–416 definition, 413 difficult circumstances auditors not present, 417 cycle count, 417 location off client’s premises, 417–418 not year-end date, 416–417 professional inventory teams, 417–418 extensive audit procedures inventory-taking instructions, 414 for material errors or fraud, 413 for misstatements, 413–414 physical inventory count, 413 manual physical inventory, 415 radio frequency identification tags, 416 Physical representation of the population, 798 Physical security controls over terminals, 892 lack of, in end-user computing, 901 Pilot sample in MUS, 841 for rate of deviations, 801 Plain-paper engagements, 604 Plaintiffs definition, 680 Securities Act of 1933, 689 Securities Exchange Act of 1934, 693 Planning and supervision, 651 advance notice, 49 audit plan, 49 failure to meet deadline, 50 interim date, 49–50 main concerns, 49 understanding client’s business, 49 Planning memorandum, 105–106 Planning precision, 801–802 Plant and equipment depreciation, 463 Plato, 634 Pointed Publications Inc., 399 Polls, sample size, 766 Ponzi scheme, 4, C37–C39 Population in attributes sampling, 777, 779–780 defining, 767 defining in MUS, 838 strata, 876 definition in attributes sampling, 798–799 expected deviation rate, 801–802 expected rate of deviation, 777–778, 780 in mean-per-unit estimation standard deviation, 877–878 stratification, 876 physical representation of, 798 selecting sample items from, 768–769 tolerable rate of deviation, 777–778 in variables sampling, 774, 777 Population size in MUS, 841 in sample size determination, 841–842 and sample size in MUS, 841−842 Population variability, 778 Porco, B., 254n Positive assurance, 599 Positive confirmation, 301–303 Index  I35 Potomac Company, Power buying, 95 Precision, 769–770, 801–802, 879–880 higher level of, 771 Precision interval, 769–770, 875, 879–880 Predecessor auditors and confidentiality, 79 definition, 78 information from, 78–79 Predication, 745 Prentice, Robert A., C7n Prepaid expenses, 354 Presentation and disclosure, 12 in acquisition and expenditure cycle, 358 by Enron, 16 finance and investment cycle, 457 revenue and collection cycle notes about confirmation, 308 revenue recognition policies, 308 of transactions and events, 15–16 Presentation and disclosure assertions finance and investment cycle, 453 financing activities, 474–475 production cycle, 401, 420 revenue and collection cycle, 285–286 Presumptively mandatory requirements, 43 Preventive controls, 184 for computer fraud, 905–906 Previts, G., Price list master file, 284 Price Waterhouse & Company, 700, C17 PricewaterhouseCoopers, 884, C17−C18 PricewaterhouseCoopers International, and Satyam scandal, C26, C28 PricewaterhouseCoopers (PwC), 41, 46, 50, 226, 501−502, 521, 545, 562, 677, 692, 700, 884 and Academy Awards, 22 on entry-level skills, independence violations, 46 and McKesson & Robbins scandal, 42 revenues in 2012, 22 Price Waterhouse India, 521 arrest of partners over Satyam scandal, C27 penalties against, C28 role in Satyam scandal, C26–C28 Pricing and compilation tests audit plan, 419 for inventory, 418–419 Primary beneficiaries, 683 Private Companies Practice Section (AICPA), 607 Private Securities Litigation Reform Act of 1995, 150, 700 Privileged information, 653 Privity, state jurisdictions, 685 Privity of contract, 680–681 Probability proportional to size (PPS) selection, 837 Problem situations, 630 Processing controls control totals, 895 in end-user computing, 902 error correction and resubmission procedures, 896 file and operator controls, 895 limit and reasonableness tests, 895–896 run-to-run totals, 895 Processing errors, systematic vs random, 886 Production, 398 Production cycle assertion risks for inventory accounts, 396 audit evidence inventory reports, 412 production plans, 412–413 sales forecast, 399 audit plans, 419, 441–442 audit risk model summary, 421 basic activities cost accounting, 398–399 inventory control, 398 production, 398 production planning, 397–398 sales forecasts, 396–397 control risk assessment account balances, 404–405 control activities, 405–406 custody, 406 direction of tests of controls, 410 entity-level controls, 405 evidence evaluation, 412 internal control questionnaire, 407, 439–440 tests of controls, 408–409 extended procedures for fraud case, 421–422 fraud incidents, 400, 406, 413, 418 illustrated, 397 inherent risks costs of goods sold manipulation, 400 inventory accounting, 400 management fraud case, 395–396 overhead allocation, 399 PCAOB report, 424–425 relation to acquisition and revenue cycles, 396–397 substantive procedures account balance assertions, 415 analytical procedures, 411 inventory fraud detection, 419 physical inventory observation, 413–416 presentation and disclosure assertions, 420 pricing and compilation test, 418–419 Production order, 398, 405 Production plan audit evidence, 412–413 definition, 397 results of errors in, 398 signing off on, 398 Production planner, 398 Production planning, 397–398 Production reports, 412–413 Professional competence, 651 Professional corporation (PC), 658 Professional Ethics Executive Committee (PEEC), 636 independence rules, 639–649 recodification of ethics standards, 637 Professional inventory teams, 417–418 Professional judgment decisions about materiality, 89 definition, 48 in implementation of materiality, 50 and internal auditors, 84–85 in real-world situations, 45 Professional skepticism auditor responsibility, 18–21 and client-colleague relationships, 20 I36  Index Professional skepticism—Cont in compliance attestation, 591–592 definition, 18, 47 on employee fraud, 228 in evaluating evidence, 19 exercise of, 47 HURTT skepticism scale, 20 inhibiting factors, 48 in making professional judgments, 19 as objectivity, 19 overcoming biases, 19 potential conflict of interest, 18 reasons for, 18 Professional Sports Authenticator (PSA), Professional standards audit confirmations, 73–74 Auditing Standards Board standards, 73 audit reporting, 73 evaluating accounting firms’ practices, 56–60 GAAS, 42–44 new, 77 PCAOB standards, 73 performance principle, 48–54 reasons for need of, 41–42 reporting principle, 54–56 responsibilities principle, 45–48 Profitability, 133 Profit inflation, 280 Profits, phony, 395 Pro forma financial information, 588 reporting on, Program change controls emergency change requests, 890 objectives, 889 system development life cycle, 889 system upgrade problems, 889 Program development controls documentation, 888–889 objectives, 887–888 problems related to, 888 systems development life cycle, 888 Program documentation and testing, lack of, in end-user computing, 901 Programmed range and reasonableness checks, 906 Programmers, 890 Projected misstatements in MUS, 845–846 Proof of cash, 257 Property, plant, and equipment (PP&E) assertions about, 355 audit procedures, 355–358 lease accounting, 455–456 Property rights, assertions about, 14–15 Proportionate liability, 700 ProQuest Company, 904 Prospective financial information, 588 Prospectus, 688 Protiviti Inc., 722 Provident Financial Group, 445 Psychotic motivation, 233 PTL Club, case auditor complicity, C7 Bakkers’ excesses, C5–C6 collapse of, C8 deception of auditors, C7–C8 effect of fraud in accounting, C9 history and popularity of, C5 lack of board oversight, C6–C7 Laventhol & Horwath involvement and collapse, C8–C9 red flags, C7 trial, C9 unfolding of scandal, C6 Public accounting see also Accounting entries assurance services, 21–23 audit services, 22 Big Four accounting firms, 22 consulting and advisory services, 23–24 CPA firms, 21 firm organization, 22 nonaudit attestation services, 22–23 professional services firms, 21 size of firms, 21 tax services, 23 terminology for employees of, 24 Public accounting firms see also CPA firms adversarial relationships with clients, 642–643 audit plan, 82–83 Big Eight reduced to Four, C17 in China, 59 client continuance or acceptance, 77–79 communication with predecessor auditor, 78–79 compliance with ethical and independence requirements, 79–80 cosourced internal audits, 722 engagement letter, 80–81 evaluating quality of practice PCAOB inspections, 58–60 system of quality control, 56–60 form and name of, 658 fraud specialists, 145 independence rules AICPA, 639–659 GAO, 649 SEC, 646–648 in India, C26 internal audit work, 723 new professional standards, 77 organized as limited liability partnerships, 699 risk management activities, 76–77 staffing, 83 termination letter, 80–81 Public Broadcasting Services, 905 Public Company Accounting Oversight Board (PCAOB), 11, 18, 43, 80, 132, 344, 521, 545 academic research on, 60 on acquisition and expenditure cycle, 364 Auditing Standards, 42 on audit quality, on broker–dealer compliance, 592–594 on component auditors, 553n conduct of, 58–60 on confirmation requests, 251 on contingent fees, 655 creation of, 42 on deficiencies in system-generated data, 189 and Deloitte & Touche, 661 Division of Enforcement and Investigation, 661 expenditure and acquisition cycle, 365 findings for attributes sampling, 814 findings on Satyam scandal, C28 Index  I37 functions, 41 and GAO standards, 738 identifying deficiencies, 59 increased public scrutiny by, 722 inspection and production cycle, 424–425 inspections of firms, 56 IT control at, 884 on IT controls at Big Four firms, 884 on management assertions, 13−14 monitoring quality, 58 number of auditing firms registered with, 58 on operational auditing, 25 overseas inspections, 59 penalties against Price Waterhouse India, C28 on professional skepticism, 47 public disciplinary actions, 660–661 reasons for, 59 reported deficiencies, 59 report on audit completion, 502 report on Deloitte and Touche, 41 report on finance and investment cycle, 482 report on production cycle, 424–425 report on revenue recognition, 290 requirements on public company audits, 204–206 restrictions on nonaudit services, 646–647 revenue and collection cycle, 316–317 rules for auditors, 635−636 on sampling deficiency, 796, 836 Staff Audit Practice Alert, 20 Staff Practice Alert, 47 on tax services, 23 on uncorrected misstatements, 514–515 website, 43 Public company audits versus nonpublic entities, 204 PCAOB requirements engagement planning, 204 evaluating management’s annual report, 206 evaluation of identified deficiencies, 205 focus on material weakness, 204 reporting on internal control, 206 tests of controls, 205 top-down approach, 204–205 types of opinions on internal control, 206 wrapping up, 206 Public entities Auditing Standards, 73 auditors’ reports for, 544–546 comparative financial statements, 544n definition, 41 filings with SEC, 542 mandatory reports, 543 standard (unmodified) report for, 546 Public regulation discipline Deloitte & Touche, 661 by PCAOB, 660–661 by SEC, 660–661 by state boards of accountancy, 660 Pull-down menus, 894 Punitive damages, BDO Seidman, 677 Purchase cutoff, 354 Purchase lead time, 398 Purchase order, 339 matched to bill of lading, 340 open, 351–352 Purchase requisitions, 338 Purchases journal, 353 Purchasing department, 340 PwC see PricewaterhouseCoopers Q Qualified opinion, 546 definition, 55 Qualitative valuation of deviation, 811 Quality assurance partner, 83 Quality audit, 2, 722 Quality control see System of quality control Quality control audits, 729 Quality control standards, 731 Qwest Communications, 288 R Racketeer Influenced and Corrupt Organizations Act (RICO) purpose, 698–699 unintended consequences, 698–699 Radio-frequency identification (RFID) for inventory, 416 Raghunanhan, K., 558 Raju, B Ramalinga, C26–C28 Raman, K K., 703 Rampart Investment Management, C37–C38 Random selection, 768, 779, 806 Range, Jackie, C27n, C29 Rate of deviation, 773 Ratio estimation, 874, 882 Rationalization of fraud, 234 Rauch Factors v Levin, 696 Ravindernath, Chintapatla, C28 Raw materials inventory, 405 status report, 398 Reagan, Ronald W., 18, 337, C5 Reasonable assurance, 128 versus absolute assurance, 175 definition, 49, 175 on financial controls, 291 impossibility of absolute assurance, 49 from program development controls, 887–888 Reasonable foreseeability, state jurisdictions, 685 Reasonableness of accounting estimates, 505 of sales forecast, 412 Reasonableness tests, 138–139 to detect fraud, 260 Reasonably foreseeable persons, 689 Reassessment of control risk, 202–203 Recalculation, 97 computer-assisted, 103 potential problems, 99 Receivables turnover ratio, 169 Receiving department, 352 Receiving reports, 341 unmatched, 352 Record counts, 894 Recording of transactions, 185 I38  Index Record keeping asset-expense and related liability, 341 for cash disbursements, 249 to detect potential fraud, 237 finance and investment cycle, 464–465 intangible assets, 451 for investments, 451 for long-term liabilities, 447–449 payroll cycle, 384 Records, physical control of, 185–186 Red flags, 79 for employee fraud, 230 for fraud, 127 missed by auditors at Parmalat, C20 missing canceled checks, 242 for profit inflation, 280 in PTL Club finances, C7 Reece, Andrew, C29 Reeves v Arthur Young, 699 Referral fees definition, 656 in Rules of Conduct, 655–656 Registrar, 447 Registration statement, 688 Regulation S-K (SEC), 691 Regulation S-X (SEC), 548, 691 Regulatory auditors, 26 Regulatory basis framework reporting requirements, 608 Regulatory factors, in inherent risk assessment, 132 Rehnquist, William, C2n, C3 Reinstein, A., 604 Reissued report, 560 Related parties, 133 definition, 455 Related-party transactions, 134 finance and investment cycle, 455 Relevance of evidence, 238 Relevant assertions definition, 119 payroll cycle transactions, 201 on significant accounts, 192, 243–244, 285–286 Relevant data, sufficient, 651 Relevant evidence, 53 Reliability, 769–770 Reliable evidence, 52–53 Reliable information factors increasing user demand for complexity, consequences, remoteness, time-sensitivity, and information risk, Remoteness, Renteria, Heribento, 763n Reperformance, 97–98 in tests of controls, 201–202 Reporting on pro forma financial information, Reporting principle, 44 adverse opinion, 55 disclaimer of opinion, 55 example of auditor’s report, 55 financial reporting framework, 54–55 and performance principle, 56 qualified opinion, 55 requirement, 54 statement of, 54 unmodified opinion, 55 Report on financial statements and related disclosures comparative financial statements, 560–562 definition, 542 disclaimer of opinion, 563 summary of financial statements, 562–563 supplementary information, 563 Reports, agreed-upon procedures engagement, 50, 588–589 Repo 105s, 504 Repo 105 transactions, C35 Republic (Plato), 634 Repurchase market, C35 Required supplementary information, 563 Research and development expenses, 357 Reserve Sewer Development Account, 337 Responsibilities, in control environment, 180 Responsibilities principle, 45–48 competence and capabilities, 45 due care, 45–47, 79 ethical requirements, 79 independence, 45–47, 79 professional judgment, 48 professional skepticism, 47 violations at Madoff Investment Securities, 48 Responsibility to the public interest, 637 Responsible party, 586 Restatement of torts, 685 Restatement of torts doctrine, 683 Restricted access to input devices, 902 Restructuring, at General Motors, C12 Retailers, cybercrimes against, 905 Retained earnings/total assets ratio, 169 Retention reviews, 78 Return on beginning equity, 169 Revenue and collection cycle audit evidence accounts receivable listing and aging, 285 cash receipts listing, 285 credit check files, 284 customer statements, 285 pending order master file, 283–284 price list master file, 284 sales analysis reports, 284 audit plan accounts and notes receivable, 334–335 tests of controls, 334 audit risk model for, 285–286 balance assertions, 285–286 basic activities accounting for accounts receivable, 282–283 billing, 282–283 credit granting, 281–282 delivery of goods and services, 282 receiving and processing orders, 281–282 control risks assessment control considerations, 291–292 summary of, 296–297 tests of controls, 293–296 dual-purpose nature of accounts receivable confirmations, 306 entity-level controls, 291 extended procedures for fraud cases, 310–315 Index  I39 fraud incidents, 292, 300, 307−308, 310–315 illustrated, 281 inherent risks collectability of accounts receivable, 290 customer returns and allowances, 290 revenue recognition, 287–289 internal control activities, 239 internal control assessment, 285–286 internal control questionnaire, 332–333 PCAOB inspections, 316–317 presentation and disclosure assertions, 285–286 profit inflation case, 280 relation to production cycle, 396–397 substantive procedures alternatives to confirmation, 305–306 analytical procedures, 300 assertions about account balances, 297 confirmation of accounts and notes receivable, 301–305 cutoff and sales returns, 307–308 presentation and disclosure, 308 review for collectability, 306–307 rights and obligations, 307 transaction assertions, 285–286 Revenue cycle assertions, 797 Revenue recognition cases of misstatement, 288 cause of financial statement restatement, 288 channel stuffing scheme, 288 definition, 287 improper, 147 PCAOB report, 290 and Philidor, 501 risk of improper, 289 SEC criteria for, 288–289 Revenues, for Big Four accounting firms in 2012, 22 Review, 22 of accounting estimates, 505 of accounts, 504–505 for collectability of accounts receivable, 306–307 of output for reasonableness, 896 Review engagement, 586 Review evidence, obtaining, 598–599 Review services see also Unaudited financial statements interim financial information, 604–605 legal liability, 586 Revolutionary War, R.H Macy & Company, C34 Rice, J C., 59n Richards, Gregory, C10 RICO see Racketeer Influenced and Corrupt Organizations Act Rigas, John, 125 Rights assertion, 14–15 Rihanna, 678 Risk appetite, 182 Risk assessment, 51–52 in audit pan, 82–83 control risk, 51 in enterprise risk management, 181–182 fraud risk factors, 127–128 inherent risk, 51 and internal control, 51 in internal control and audit team work, 181–182 business risks, 181 by management, 181–182 principles of, 183 requirements, 51 and risk of material misstatement, 51 substantive procedures, 51 types of fraud, 128–129 Risk consciousness, 182 Risk management activities, 76–77 management responsibility, 119–123 Risk of assessing control risk too high, 774, 800 Risk of assessing control risk too low, 774, 800 Risk of incorrect acceptance, 776 establishing level of, 839 in MUS, 840 and precision level, 879 and sample size in MUS, 842 and upper limit on misstatements, 847–848 Risk of incorrect rejection, 776 in mean-per-unit estimation, 876–877 in MUS, 840 Risk of material misstatement, 836 Risk of material misstatement (RMM) acquisition and expenditure cycle, 349 assessing control risk, 178 inherent risk, 178 in cash management, 244 control activities, 183 control risk reassessment, 202–203 definition, 51, 119 due to fraud, 129 finance and investment cycle, 457 mitigating, 87 necessary relationships, 51 primary purpose of assessing, 51 production cycle, 402–403 revenue and collection cycle, 287 situations resulting in, 135–136 substantive procedures for, 203 tests of controls auditing, 183 Risk of overreliance, 774 in sample size, 802 in sampling risk, 800–801 in upper limit rate of deviation, 808 Risk of underreliance, 774 in sampling risk, 800–801 Risk(s) in audit engagement, 76–77 of improper revenue recognition, 289 information for assessing and responding to AICPA guides, 137 assessing risk factors, 147–148 audit planning, 138 board of director minutes, 138 brainstorming sessions, 144–145 client acceptance or continuance evaluation, 138 communicate fraud risks, 148–149 company sources, 138 document risk assessment, 147 evaluate results of procedures, 148 general business sources, 137–138 inquiry, 145 I40  Index information for assessing and responding to—Cont Library of Congress website, 137 past audits, 138 preliminary analytical procedures, 138–144 responding to significant risks, 147–148 sources of, 182 types of, 119 Rizzo, Tom, 903 RMM see Risk of material misstatement Roberts, Eric, 413 Robin Hood theory, 234 Roll-forward procedure, 504 Rollover method, 514 Rolls-Royce, 541–542 Rolls-Royce Power Systems, 541 Roosevelt, Theodore, 628 Roper, Barbara, C25 Rosenblum v Adler, 684, 696 Rosen Canada Ltd., 359 Royal Ahold, 288 Rules of Conduct (AICPA), 636–637 accounting principles, 651 acts discreditable, 656 advertising and solicitation, 657 commissions and referral fees, 655–656 compliance with standards, 651 confidential client information, 652–654 contingent fees, 654–656 form and name of accounting firms, 658 general standards, 651 integrity and objectivity, 650–651 Rule-utilitarianism, 634 Rumman, Ahmed, C29 Run-to-run totals, 895 Rusch Factors v Levin, 683 S Sachdeva, Sujata, 300 Safan, Ronald, 515–516 Safety-Kleen Corporation, 288, 677 Sage 50, 99 Sales analysis reports, 284 Sales cutoff tests, 307 Sales detail (journal) file, 284 Sales forecast audit evidence, 399 definition, 396–397 same as last year scheme, 412 Sales invoice, 282, 886 Sales transactions automated processing, 885–886 occurrence and completeness of, 188 Sale transaction file, 886 Salterio, S., 516 Salzman, Gerald, C31 Same as last year (SALY) scheme, 412 Same-store-sales ratios, C40 Sample estimate of misstatement, 775 Sample evaluations, confidence factors for, 846 Sample evaluation tables, 834 Sample items in mean-per-unit estimation, 879 measurement in attributes sampling, 806–807 measurement in MUS, 844–845 audited value, 844–845 and nonsampling risk, 845 tainted percentage, 845 measuring, 769–770, 779 nonstatistical sampling, 881 selection block selection, 769, 779 haphazard selection, 768, 779 nonstatistical percentages, 769 systematic random selection, 768, 779 unrestricted random selection, 768, 779 Sample rate of deviation, 773–774, 808–810 calculating, 808–809 fallacy of approach, 808 Sample results evaluation adjusted average, 770 precision, 769–770 precision interval, 769–770 reliability, 769–770 Sample selection in mean-per-unit estimation, 878 in MUS example, 843 logical unit, 843 sampling interval, 843 systematic random selection, 842 Sample selection, in attributes sampling, 805–806 Sample size appropriate, 765 attributes sampling factors affecting, 802–803 large vs small population, 802 risk of overreliance, 802 using AICPA sampling tables, 803–804 in difference estimation, 881 direct relationship or expected rate of deviation, 777–778 inverse relationship of tolerable misstatement, 777–778 in mean-per-unit estimation calculating, 877–878 formula, 876 risk of incorrect rejection, 876–877 standard deviation, 877–878 in MUS direct relationship with expected misstatement, 841 inverse relationship with tolerable misstatement, 840 nonstatistical variables sampling, 818–819 in ratio estimation, 882 sampling risk, 777–778 standard deviation, 778 and tolerable rate of deviation, 777–778 variables sampling, 836 Sample size determination, 768 attributes sampling expected population deviation, 801–802 population size, 802 sampling risk, 800–801 tolerable rate of deviation, 800 expected rate of deviation, 777–778, 780 key factors in, 777–778 Index  I41 in MUS effect of factors on, 842 factors influencing, 839–842 interpolating table values, 872–873 and population size, 777–778 Sample size tables, 832–833 Sampling see also Attributes sampling; Monetary unit sampling; Variables sampling audit use attributes sampling, 773–775 sampling risks, 776 variables sampling, 775–776 basic steps, 767–772 defining characteristics of interest, 767 defining the population, 767 determining objective, 767 determining sample size, 768 documentation of procedures, 771–772 evaluation of sample results, 769–770 sample items measurement, 769–770 sample items selection, 768–769 by Bureau of Labor Statistics, 770 documentation of procedure, 771–772 efficiency vs effectiveness trade-off, 764 and nonrepresentative sample, 765 polling data, 766 of population, 763 statistical vs nonstatistical, 766 Tyson Foods employee compensation, 762–763 of voters, 763 when to use, 764 need for exact information not important, 764 number of items comprising population not large, 764 Sampling deficiency PCAOB on, 796 for tests of controls, 796 Sampling deficiency PCAOB on, 836 Sampling error, 764 Sampling interval definition, 768, 806 in MUS, 843 Sampling risk allowance for, 770 attributes sampling, 773–774 risk of overreliance, 800–801 risk of underreliance, 800–801 definition, 765 in determining population size, 777–778 MUS risk of incorrect acceptance, 840 risk of incorrect rejection, 840 versus nonsampling risks, 764–766 and sample size in MUS, 839–842 statistical and nonstatistical sampling, 766 Sampling unit in classical variables sampling, 878 in MUS, 842–843 Sam’s Club, 416 Samson, W., San Diego city officials, 457 SAP, 99 Sarbanes–Oxley Act, 42, 77, 130, 144, 355, 509, 636, 678, 687, C4, C16 and audit fees, C24 on auditor responsibilities, C23 on auditors and internal control, 177–178 on communication between auditor and audit committee, 522 costs of compliance with, C23 on criminal penalties, 694 effect on accounting firm revenues, C24 effect on IPOs, C23 effects on legal liability alteration or destruction of documents, 698 extended statute of limitation, 698 increased penalties, 698 sentencing guidelines, 698 on employee hotline, 235 and financial frauds of 2001, 639 on financial reporting, 174–175, 204 General Electric’s view of, C23 impetus for passage of, 697 increased public scrutiny from, 722 increase in SSAE 16 reports resulting from, 595 on internal audits by CPA firms, 725 internal control definition, 175 on management and internal control, 175–176 on management’s responsibility for financial reporting, 12 modification of SEC independence rules, 648–649 on nonaudit services, C17, C23 on PCAOB inspections, 521 prohibition of consulting services, 639 on quality control standards, 57 reasons for passage of, 41, 174 and reduction in initial public offerings, 207 Satyam Computer Services, Ltd., 251, 521 Satyam Computer Services, Ltd., case and accounting in India, C26 arrest of auditors, C27 arrest of officers, C28 company history, C26 discovery and investigation of fraud, C26–C27 fictitious wages, C27 financial accounting reconciliation team, C27 fraudulent financial accounting, C26 PCAOB findings, C28 penalties for auditing firms, C28 penalties for company, C28 PricewaterhouseCoopers and, C27–C28 software to create altered invoices, C27 subject to SOX, C26 unrecorded liabilities, C27 Satyam Computer Services subject to, C26 Scanning, 95 computer-assisted, 103 potential problems, 99 Schedule of interbank transfers, 255–256 Schelluch, P., 590 Schmidt, J., 703 Schmidt, Mike, Schmidt, Susan, 172 Schmidt, William E., C10 Schnitzer Steel Industries, 151 Scholz, S., C32n Scienter, 692 Scientific-Atlanta Inc., 510 Scope and nature of services, 637 I42  Index Scope limitation, 224–225 circumstances-imposed, 549 client-imposed, 549 disclaimer of opinion, 551 implications of client-imposed limitation, 551 modifications to standard (unmodified) report, 552 qualified opinion, 549–552 situations creating, 549–550 Scrushy, Richard, 125, C14–C16 Search for unrecorded liabilities, 352–353 definition, 353 procedures, 353–354 Sears, 726, 729 Sears, Roebuck and Company, C34 Sea View Video Technology, 288 SEC Board, India, C28 Second-partner review, 517 Securities Act of 1933, 680, 688–690 antifraud section, 690 auditors’ defenses, 689–690 causation defense, 690 due diligence defense, 690 civil liability, 688–689 criminal liability section, 690 importance for auditors, 688 legal precedents Escott v BarChris Construction Corporation, 689 United States v Benjamin, 690 provisions, 688 Section 11 provisions, 688 sources of liability under, 687 statute of limitations, 690 summary of liability under, 695–696 Securities and Exchange Commission (SEC), 9, 11, 42, 127, 136, 150, 629 see also Staff Accounting Bulletins and Ambassador Eyewear Group, 308 and Andersen LLP, C1–C2 and AOL Time Warner, 651 auditor independence, 47 broker–dealer compliance and, 592 and Chinese accounting firms, 59 on comparative financial statements, 560 criteria for revenue recognition, 287 definitions related to independence, 641 and Dell Inc., 178 EDGAR database, 79 filing audited financial statements with, 501 Financial Reporting Releases, 691 Form 8-K, 79, 149, 520, 691, C30 Form 10-K, 542, 691, C30–C31 Form 10-Q, 691, C31 and HCA, 384 and HealthSouth, C15−C16 on independence, 46 independence rules factors causing loss of independence, 646–648 fee disclosure, 648 independence in appearance, 646 independence in fact, 646 nonaudit services, 646–647 on internal audits by CPA firms, 725 and KPMG, 515–516, C4 Madoff Investment Securities and, C37–C38 mandate on XBRL, 613 material misstatements, 406 and McKesson & Robbins scandal, 42 on nonaudit services, 23 and NutraCea, 296 on operational auditing, 25 oversight of accounting and auditing, 56 penalties against Price Waterhouse India, C28 and Philidor, 501 public disciplinary actions, 660–661 public entity filings with, 542 registration statement, 688 Regulation S-X, 548 required audit fee disclosures, C24–C25 revenue recognition, 290 rules of conduct, 636 and San Diego city officials, 457 and Sirena Apparel Group, 307 Staff Accounting Bulletins, 691 10-K filings, 501, 509 10-K reports, 137 10-Q filings, 509 undercover sting, C33 XBRL requirement, 11 Securities count, 451 Securities Exchange Act of 1934, 680, 691–695 antifraud section, 691–692 auditors’ defenses under, 693 civil liability, 693 criminal liability section, 694 Foreign Corrupt Practices Act as amendment to, 694 legal precedents Ernst & Ernst v Hochfelder, 692 United States v Natelli, 694 on previously issued opinions, 698 provisions, 691 Rule 10b-5, 691–692 statute of limitations, 693 summary of liability under, 695–696 Securities Litigation Uniform Standards Act of 1998, 701 Selendy, Philippe Z., 765 Self-regulated profession, 41 Self-regulation, 659 Self-regulatory discipline, 659–660 Self-review threat, 642 Sentencing guidelines, 698 Separation of duties acquisition and expenditure cycle, 346 authorization, 185 benefits, 185 compensating controls in end-user computing, 902 in computerized environment, 184–185 in computer operations controls, 890 custody of assets, 185 finance and investment cycle, 460 and incompatible responsibilities, 185 lack of, in end-user computing, 901 payroll cycle, 387 payroll preparation, 384 periodic reconciliation, 185 to prevent employee fraud, 237 recording, 185 revenue and collection cycle, 291 Sequence tests, 895 Index  I43 Sequential sampling definition, 813 disadvantages of, 813 low population deviation rate, 813 operation of, 813 Serious Fraud Investigation Office, India, C27−C28 Service Corporation International, 595 Service organizations attestation engagement, 594–597 control reports, 9, 594–597 definition, 594 fraud case, 388 functions, 388–389 reasons for using, 903–904 reports to auditors from, 903–904 SharePoint Technology, 903 Shaw, Bryan, 629, C33 Shearson Lehman Hutton, C34 Shefchik, L., 59 Shell company, 340 Shell Corporation, 479–480 Shockey, L Jackson, 636 Siegelman, Don, C16 Siemens AG, 151, 694 Sight verification, 894, 902 Signatures, 106 Significant account or disclosure, 119 Significant accounts, relevant assertions, 192, 243–244, 285–286 Significant deficiencies communication of, 207–208 definition, 206 Significant differences defining, 139 investigating, 139–141 Significant risks definition, 147–148 responding to, 147–148 Silva, Gino, 413 Simplified Employment Services, 256 Sinason, D., 741n Singer, B., 594 Singer, M G., 634n Singhal, Shelly, 134 Single audit definition, 738 example, 740 requirements for auditors, 738 Single Audit Act Amendments of 1996, 738–739 Single Audit Act of 1984, 737–739 Sirena Apparel Group, 307 Siva, Pulavarthi, C28 Skechers USA Inc., 80, 630, C33 SK Foods, 340 Skilling, Jeffrey, 125, 181 Skill sets, 30 Skimming, C40–C42 Smith v London Assurance Corporation, 681, 696 Snyder, Steve, 187 Social Security Administration, 387 Social structures, new, 612 Société Générale, 891 SoftBank Corp., 559 Software, 102–103 for audit documentation, 104 for computer-assisted audit techniques, 102, 144 designed to generate altered invoices, C27 Sole proprietorship, 658 Solicitation, in Rules of Conduct, 657 Sonal, Joshi, C29 Sony Corporation, 905 Sophocles, 227 Source documentation, 95, 188 SOX see Sarbanes-Oxley Act Spears, William, C6 Special and restricted-use reports on application of requirement of appropriate financial reporting framework, 609–611 special-purpose framework, 607–609 specified elements, accounts, or items in financial statements, 606 Special events report, 79 Specialists auditor knowledge of, 85 definition, 85 Special-purpose entities (SPEs), 444, 447 Special-purpose framework auditing standards, 607–608 auditors’ report, 608 definition, 607 examples, 607 versus GAAP, 607 promoted by AICPA, 607 titles used in, 607 Split-strike conversion strategy, C37 Spreadsheet controls, 903 Spreadsheet goofs, 187 Sprint Communications, 559 Squar Milner LLP, C31 SRSR Holdings, C27 Staff Accounting Bulletins (SEC), 691 No 99, 515 No 108, 514 Staffing audit engagement, 83 Standard and Poor’s, 142, 472 Standard costs, 398 Standard deviation, 778 in mean-per-unit estimation, 877–878 Standard error of the mean, 778 Standardized formats and screens, 894 Standard screens, 902 Standards of fieldwork, 44 Standards of reporting, 44 Standard (unmodified) report see also Auditors’ report(s) introductory paragraph, 543 major sections, 543 for nonpublic entities, 543 opinion paragraph, 543 for public entities, 546 purpose, 543 signing and dating of, 544 situations requiring language modification departure from GAAP, 547–548 involvement of component auditors, 553–554 scope limitation, 549–552 types of opinions in, 546 Star Air Ambulance Service, 359 Starbucks, 615−616, 902 State boards of accountancy, public disciplinary actions, 660 I44  Index State certification and licensing, 29–30 substantial equivalency, 30 State insurance board auditors, Statement of Financial Accounting Concepts (SFAC) No. 2 “Qualitative Characteristics of Accounting Information,” 16 Statements of Financial Concepts, 338 Statements of Responsibilities in Tax Services, 23 Statements on Auditing Procedures (SAPs), 6n, 42 Statements on Auditing Standards (SASs), 6n, 42, 73, 74 and International Standards on Auditing, 43 Statements on Quality Control Standards, No 8, 56–57 Statements on Standards for Accounting and Review Services, 598 Statements on Standards for Attestation Engagements, 6n, 586, 639 State of Arizona v Wayne James Nelson, 743–744 States audit agencies, 733–734 blue-sky laws, 687 jurisdiction classifications near privity, 685 privity, 685 reasonable foreseeability, 685 restatement of torts, 685 and Single Audit Act, 738–739 State Street Trust Co v Ernst, 683 Statistical inventory counting, 417 Statistical sample selection, 769 Statistical sampling auditor’s use of, 766 court ruling on, 765 definition, 766 Statute of limitations extended by SOX, 698 in Securities Act of 1933, 690 Statutory law, 680 Statutory liability definition, 687 Foreign Corrupt Practices Act, 694 primary legislation, 687 Stefaniak, C M., 516 Stein Mart Inc., 406 Sting operation, 629 Stock, and transfer agents, 447 Stock certificate book, 449, 465 Stockholders’ equity, substantive procedures, 476 Stock price collapse at Enron, 444 Stock price performance, General Motors, C11 Stock transactions, 476 Stolper, Andrew, 413 Stone, Sharon, 413 Stoneridge Investment Partners v Scientific-Atlanta, 699 Strata, 876 Strategy implementation, and risk of material misstatement, 136 Stratification, 144, 876 Strong, George, C15 Subjective estimates, 132 Subprime accounting at Lehman Brothers, C34–C36 Subprime lending crisis, 678, C34 Subsequent events, 559 auditors’ objective, 517–518 and audit timeline, 520 company examples, 517 definition, 517 learning about, 517–518 procedures to identify, 517–518 types of, 518 Subsequently discovered facts and auditors’ report, 519–520 auditors’ response to, 519–520 and audit timeline, 520 definition, 519 dual dating, 519–520 management action, 520 Substantial doubt on going-concern uncertainties, 513 Substantial equivalency, in state licensing, 30 Substantive audit plan definition, 91 and risk assessment, 91 Substantive procedures, 836 see also Monetary unit sampling acquisition and expenditure cycle, 351–358 for audit of cash, 250–256 bank reconciliations, 251–255 proof of cash, 257 schedule of interbank transfers, 255–256 substantive tests, 251 audit sampling, 772 categories of, 120 and control risk, 203 definition, 51 to detect misstatements, 203 for evaluating evidence, 52 finance and investment cycle audit plans, 497–499 financing activities, 474–477 investing activities, 471–474 nature, timing, and extent of, 796 planning, 90 production cycle, 411–420 revenue and collection cycle, 297–308 variables sampling, 836 Substantive tests finance and investment cycle, 466–467 of transactions, 358 ways of conducting, 91 Sufficiency of evidence, 53 Summary financial statements, 562–563 Sunbeam Corporation, 504, C1 Supervision, payroll cycle, 383 Supplementary information, 558–559, 563 Supreme Court, 657 Sureparts Manufacturing Company, 301 Survey Research Center, University of Michigan, 765 Sustainability, 615 Prince Charles on, 730 Sustainability audits, 729 Sustainability reporting, 8, 615 Systematic random selection, 768, 779 attributes sampling, 806 in MUS, 842–843 Systematic selection, 806 System of quality control acceptance and continuance of client relationship, 57 engagement performance, 58 human resources, 57–58 leadership responsibilities, 57 Index  I45 monitoring, 58 purpose, 56–57 relevant ethical requirements, 57 Systems analysts, 890 Systems development and modification controls, in end-user computing, 903 Systems development life cycle (SDLC) diagram, 888 effectiveness, 888 feasibility analysis stage, 888 in program change controls, 889 systems specifications, 888 System upgrades, 889 SysTrust Service, 614–615 T T J Maxx, 905 Tagg, Stephen, 795 Taggart, David, C7, C9 Taggart, James, C9 Tainting percentage, 845 Tangible assets, inspection of, 96, 99 Tanner, Tony, C15 Tanzi, Calisto, 125, C20–C22 Target Corporation, 282, 399, 402–403 Tarpley, R., 126n Tax basis framework reporting requirements, 608 Tax consulting fees, KPMG, C18 Taxes, improperly accounting for, 342 Tax-exempt organizations, IRS on, C7 Tax fraud, KPMG, C18 Tax partners, 83 Tax reports, 386–387 Tax services, 647 of public accounting firms, 23 Technical controls for computer fraud, 906 Tellabs, Inc v Makor Issues and Rights Ltd., 695–696 Temple, Nancy, C2, C4 10-K filings (SEC), 137, 501, 509 10-Q filings (SEC), 509 Termination letter, 80–81 Tervo, W., 59n Test basis, 772 Tests of controls, 807 accounting estimates, 463–464 acquisition and expenditure cycle assertions about transactions, 349–351 completeness assertion, 349 direction of tests, 349 occurrence assertion, 349 direction of completeness direction, 202 occurrence test, 202 finance and investment cycle, 466 and inherent risk, 204 in IT environment automated application controls, 900 general controls, 900 testing methods, 901 over cash disbursements, 249 over cash receipts, 247–249, 278 performing criteria for choosing tests, 202 document examination, 201 hierarchy of tests, 202 methods, 200 reperformance, 201–202 production cycle direction of, 410 production reporting system, 409 transaction assertions, 408–409 in public company audits, 204 revenue and collection cycle accounts receivable, 296 assertions about transactions, 294 in audit plan, 334–335 components, 295 dual-direction testing, 294–296 in risk of material misstatement, 178 on samples throughout audit period, 200 sampling deficiency, 796 Tests of details, 120, 358, 796, 836 Tests of details risk audit risk model to determine, 836 definition, 836 similarity to risk of incorrect acceptance, 836 Theft, 228–229 at Tommy Hilfiger Group, 382 Thibodeau, J C., 136, 254n Third parties, 685–686 limits on auditor liability, 702 Thompson, Bill, 679 Thornton, Grant, 127 Tidwell, Gary L., C10 TierOne, 678 Time, 721 Time budgets example, 86 and interim audit work, 85–86 purpose, 85 time reports, 87 and year-end audit work, 86 Timekeeping, 383 Time reports, 87 Time-sensitivity, Titus, H H., 632 TJX Companies Inc., 905 Todman and Co., 698 Tolerable misstatement, 87–88, 773, 775–776 Tolerable misstatement, in MUS after calculating performance materiality, 840 inverse relationship with sample size, 840 sample size, 840, 842 Tolerable rate of deviation (TRD), 773, 777–778 definition, 800 and expected population deviation, 801 inverse selection to sample size, 804 in sample size determination, 800 Tommy Hilfiger Group, 382 Tonneson Fleet Bank, 684 Top-down approach, 204–205 Topps Mike Schmidt baseball cards, Tort actions definition, 680 fraud, 681 I46  Index Tort actions—Cont gross negligence, 681 liability to third parties, 685–686 ordinary negligence, 681 Toshiba, 135 Touche, Niven & Company, 682–683 Touche Ross, C17, C41 Tracing, 95 Trademarks, 450 Transaction assertions finance and investment cycle, 455 production cycle, 401, 409 revenue and collection cycle, 285–286 Transaction-level controls, 192 Transaction logs, in end-user computing, 903 Transaction processing, potential IT problems, 886 Transactions, 12 see also Monetary unit sampling authorization of, 100, 237 classifications of, 15–16 complex, 131, 454 fair value measurements, 472–473 initiation of subsequent execution of, 100 investing, 449–451 occurrence assertion, 13–14 presentation and disclosure, 15–16 in production cycle, 397 related-party, 133–134 separation of duties authorization, 185 custody of assets involved in, 185 periodic reconciliation, 185 recording, 185 stock, 476 substantive tests of, 358 uniform processing, 100 variables sampling for, 775–776 volume of, 131 walkthrough, 193 Transaction trails, 99–100 TransAlta Corporation, 187 Transfer agents, 447, 476 Transparency, demands for, 612 Treadway, James, 175 Treadway Commission, 175, 182n, 811 Trial balance accounts payable, 352–353 accounts receivable, 285 aged, 285 Trial board, 659–660 Tricontinental Industries v PricewaterhouseCoopers, 693 Tripathi, Salil, C29 Trompeter, G., 144 True balance, 836 Trustee, 449 Trust services ASEC Trust Information Integrity Task Force, 614 e-commerce security issues, 614 engagement principles, 615 SysTrust Service, 614–615 WebTrust Service, 614–615 Truth-in-securities laws, 687 Turner, Lynn E., 678 Twain, Mark, 628, 762 Tyco International, 2, 124, 445, 677, 701 Tyson Foods, 400–401, 762–763 U UAG UK Holdings Limited, 555 UBS, 517 Ullsten, Ola, C26 Ultramares Corporation v Touche, 682–683, 696 Unasserted claim, 508 Unaudited financial statements liability in connection with, 586 review or compilation services accountants’ responsibility, 601–602 additional paragraph, 600 communication with predecessor accountants, 600 comparative financial statements, 600 compared to audits, 601 documentation of engagement, 599 fraud detection, 599 negative assurance, 599 obtaining evidence, 598–599 personal financial plans, 601 plain-paper engagements, 604 prescribed forms, 600 purpose, 598 types of reports, 602 Uncorrected misstatements, 514 effect on future year, 514 evaluating materiality of iron curtain method, 514–515 rollover method, 514 PCAOB on, 514–515 Understandability, 15–16 Undue influence threat, 642–643 Uniform CPA Examination, 27–28 Uniform processing of transactions, 100 United Airlines, 896 United Auto Workers, C12 United Parcel Service, 612 United Rental, 702 United States Congress government audits sent to, 732–733 reliance on Government Accountability Office, 733 United States Public Company Reform and Investor Protection Act of 2002, 697 see also Sarbanes-Oxley Act United States Supreme Court on aiding and abetting, 699 Arthur Andersen ruling, 444, C3, C17 on auditor liability, 695–696 on auditors and RICO, 699 on class action suits, 701 on materiality, 87 United States v Benjamin, 690 United States v Natelli, 694 Univer, Scott, 676 University of Phoenix, 687 University of Texas, 450 Unmatched invoice file, 352 Unmatched receiving report file, 352 Unmatched receiving reports, 352 Unmatched vendor invoices, 352 Index  I47 Unmodified opinion, 546 definition, 55 Unqualified opinion of Daily Journal, C31 defined, 55 on internal control, 206 on internal control over financial reporting, 221− 222 Unrecorded liabilities, 345, C27 Unregistered sale of securities, 477–478 Unrestricted random selection, 768, 779 attributes sampling, 806 Updated report, 560 Upper limit on misstatements in MUS auditors’ use of, 847–848 example, 849 risk of incorrect acceptance, 847–848 tolerable misstatement, 848 in sampling risks, 775 Upper limit rate of deviation (ULRD), 773 calculating, 808–810 components, 809 information provided by, 808 U.S Federal Reserve Bank of New York, 884 U.S Premium Beef LLC, 50 User demand for reliable information business risk, and financial accounting frauds, information risk, User entity, 903 Usrey, S., 516 Utilitarianism, principle of, 634 V Vadlamani, Srinivas, C27 Valeant, 501 Valid character tests, 895 Valid sign tests, 895 Valuation and allocation and tracing, 95 assertions about, 15 of financial instruments, 463 inspection for, 96 of inventory, 418–419 recalculation for, 97 Valuation assertion in mean-per-unit estimation, 875 in MUS, 383 nonstatistical sampling, 881 Valuation services, 647 Value-added audit improving economy and efficiency, 725–726 insuring compliance with management directives, 726 objectives, 725 recognizing and analyzing risks, 725 serving as management representative, 726 Valukas, Anton R., C36 Variables sampling see also Classical variables sampling; Monetary unit sampling for account balances or transactions, 775–776 audited value, 839 auditors’ use of, 775–776 definition, 836, 849 detection risk, 776 documenting, 850–851 objectives, 839 population, 777 sampling risk actual misstatement, 775–776 risk of incorrect acceptance, 776 risk of incorrect rejection, 776 tolerable misstatement, 775–776 upper limit of misstatement, 775–776 tests of details risk, 836–837 true balance, 836 Venable, Carol F., C10 Vendor invoices, 341 unmatched, 352 Ventas Inc., 47 Ventimiglia, Mike, 413 Verbal inquiry, 96 Verizon, 452 Verizon Wireless, 452 Vertical analysis definition, 139 to detect fraud, 259–260 Vines, Michael, 146, C15 Virtue ethics, 634–635 Volkswagen Credit Inc., 413 Voucher, for purchase orders, 341 Voucher package, 341 Vouching, 94–95 potential problems, 99 research and development, 357 W Wabtec Corporation, C17 Wagoner, Rick, C11−C12 Walkthrough, 193, 205 for cash management, 248 revenue and collection cycle, 291 of sales transaction, 885 Wall Street Journal, 137, 207 Walmart, 50, 416, 701, 726 Walt Disney Company, 481 Wang, D., C32n Wang, X., 558 Wasendorf, Russell, Sr., 254 Washington, George, Washington Post, C6 Waste Management Inc., 344, C1−C2 Watson, Robert, 340 Webb, A., 516 Weber, J., C10 Websites Library of Congress, 137 for rule-making bodies, 43 Webster, Daniel, 443 WebTrust Service, 614–615 Wee, Chua Peck, 344 Weighted-average costing, 398 Weisbaum, Jack, 677 Wells, Joseph T., 237, 259n, 396n Wells Fargo, 254 I48  Index What Could Go Wrong (WCGW) approach, 345, 402 Wheelwright, Philip, 630 Whistle-blowing, 653, C33 Whitcher, Craig, C29 White, Mary Jo, 290 White-collar crime, 128 White-collar criminal behaviors, 230–231 characteristics, 230–231 Whitehouse, Tammy, 128 Whitman, Meg, 133 Wilkins, M S., C32n William Iselin & Company, 586 Williams, C., 675n Williams, D D., 558 Willingham, J J., 230n, 232n Willkie Farr & Gallagher, 678 Winkler, Stephan, 248 Wolfe, C J., 542n Wood, D A., 455 Woodruff, Wardlaw, Nelson and Cash, 364 Working capital/total assets ratio, 169 Work in progress controls, 406 Workpapers, 104 Workplace, managing people pressures, 235–236 World Basketball League, 95, 423 WorldCom, 2, 4, 12, 16, 41−42, 57, 77, 124, 147, 343, 348, 504, 631, 635, 639, 697, 701, C1, C4, C34 fraud at, 173−174 misstatements in financial statements, 721 World Electronics LLC, 421 World Poker Team, 79 Worthington Industries, 419 WPT Enterprises Inc., 79 Wright, A., 142, 514n, 523 Wright, S., 514n Write-downs, 419 Write-offs, 457 Written representations, 509 contents and form, 509–512 dating of, 509 evidence in, 509 versus substantive procedures, 509 W-2 reports, 382–384, 387 Wyden, Ron, 733 X XBRL Assurance Task Force, 613 XBRL (eXtensible Business Reporting Language) reporting, 10−11, 613 Xerox Corporation, 174, 288, 445, 515–516, 677 Xinhua Finance Ltd., 134 Y Yahoo!, 146, 452 Yahoo! Finance, 142 Yates, Buddy, 336 Year-end adjusting entries, 147 Year-end audit work, 86 Year-end date, inventory not on, 416–417 Year-to-date earnings records, 387 Yellow Book, 733, 739, 741 Yesilevich, A., 456 Young, Michael, 677−678 Yuen, Henry, 125, 510 Z Zeff, Stephen A., C17n Zhang, T C., 60 Zhang, Y., 60 Zhou Limin, 661 Zimbelman, M F., 234 Z-score, 169 ZZZ Best, 99 ... the auditing field to this new edition of Auditing & Assurance Services, supplying the necessary investigative tools for future auditors Cutting-Edge Coverage The seventh edition of Auditing & Assurance. .. international standards of auditing (ISAs) and the Auditing Standards Board (ASB). With Auditing & Assurance Services, seventh edition, students are prepared to take on auditing s latest challenges... faculty Although Auditing & Assurance Services, 7e, and the teaching package make no claim of any specific AACSB qualification or evaluation, we have within Auditing & Assurance Services, 7e, labeled