Professional Documents
Culture Documents
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 Accoun-
tancy and Northern Illinois University Awards for Excellence in Undergraduate Teaching.
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 Inter-
national Auditing and Assurance Standards Board, Auditing Standards Board, and Public
Company Accounting Oversight Board. To acquaint students with the professional stan-
dards, 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
1
“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 finan-
cial 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 pre-
pared to enter practice with an appreciation for and knowledge of the increasing impor-
tance 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.
Chapters Modules
The 12 chapters cover the auditing Modules A–H provide instructors
process extensively with a multitude of additional material that can be used
cases designed to give students a better throughout the course. Topics such as
understanding of how a best-practice fraud, ethics, sampling, and technology
concept developed from real-world are covered in the modules, which are
situations. designed to be taught whenever instruc-
tors want to introduce the topic in their
course.
ix
achieve this goal. Although the chapters follow a logical sequence that we recommend
professors consider for their classes, the modules have been written to be used on a
stand-alone basis. In essence, the modules have been deliberately prepared for entirely
flexible implementation of these topics without excessive reliance on chapter sequenc-
ing. We encourage you to integrate these modules into your syllabi in a manner that best
suits your approach to the auditing course.
∙ Mini-cases that may be assigned to supplement Risk comes from not knowing what you’re doing.
text chapters and modules that expose students to Warren Buffett, widely regarded as one of the most successful investors in
the world
xi
IDEA Software and Workbook
With the availability of unprecedented amounts of quantitative and qualitative infor-
mation and tools available to access and process that information, it is imperative that
students learn and utilize the latest technologies used by auditing professionals. As
previously stated, McGraw-Hill Education has forged a partnership with Caseware
Analytics for the use of the IDEA data analysis tool. Chapters 3 (audit planning), 4 (risk
assessment), 5 (internal control), 7–9 (operating cycle chapters), Module F (attributes
sampling), and Module G (variables sampling) have been revised to reference the use of
IDEA within the chapter or module.
In addition, the seventh edition includes end-of-chapter exercises utilizing author-
developed databases exclusively for use with Auditing & Assurance Services as well
as supplemental materials available in Connect to complement the IDEA workbook and
provide hands-on instructions on using the IDEA software. The authors also provide
implementation guidance to instructors and detailed solutions and explanations on this
new content. Overall, the author team has provided significant resources to prepare stu-
dents for the auditing environment in 2017 and beyond.
TestGen
TestGen is a complete, state-of-the-art test generator and editing application software
that allows instructors to quickly and easily select test items from McGraw Hill’s Test-
Gen testbank content and to organize, edit and customize the questions and answers to
rapidly generate paper tests. Questions can include stylized text, symbols, graphics, and
equations that are inserted directly into questions using built-in mathematical templates.
With both quick-and-simple test creation and flexible and robust editing tools, TestGen
is a test generator system for today’s educators.
xii
Association to Advance Collegiate Schools of
Business (AACSB) Statement
McGraw-Hill Education is a proud corporate member of AACSB International. Under-
standing the importance and value of AACSB accreditation, Auditing & Assurance
Services, 7e, recognizes the curricula guidelines detailed in the AACSB standards for
business accreditation by connecting selected questions in the text and test bank to the
eight general knowledge and skill guidelines in the AACSB standards. The statements
contained in Auditing & Assurance Services, 7e, are provided only as a guide for the
users of this textbook. The AACSB leaves content coverage and assessment within the
purview of individual schools, their mission, and their 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 selected questions according to the eight general knowledge and skills areas.
xiii
New to the Seventh Edition of
In response to feedback and guidance from numerous auditing accounting faculty, the authors have made many
important changes to the seventh edition of Auditing & Assurance Services, including the following:
Assurance Services as well as supplemental materials to
Highlights of Auditing & complement the IDEA workbook are provided.
Assurance Services, 7e ∙ Coverage in the cycle chapters has been standardized to focus
on the risk assessment process for each relevant assertion.
∙ The seventh edition of Auditing & Assurance Ser- In addition, the chapters provide a consistent focus on how
vices features Connect and SmartBook. auditors respond to assessed risk of material misstatement,
∙ All chapter and modules have been revised to incorpo- through the incorporation of easy-to-read tables throughout
rate professional standards adopted through May 2016. Chapters 6 through 10 to highlight the key issues and risks
In addition, the reorganized PCAOB framework (which faced by auditors in the examination of different accounts.
becomes effective December 31, 2016) has been utilized These tables take the students through the risk assessment
throughout the text. process for each cycle on a step-by-step basis to mirror the
methodology used in current audit practice.
∙ Auditing Insight boxes have been added and updated
throughout the textbook to place issues discussed within ∙ Five new Mini-cases have been added that feature
the text into a real-world context. These boxes incorporate Bernie Madoff Investment Securities (failure of auditors
numerous examples from business and academic publica- and regulators to detect fraud); Crazy Eddie’s (failure of
tions as well as actual company annual reports and audit auditors to detect fraud); Daily Journal Corporation (audi-
reports. tor changes and internal control reporting); Lehman Broth-
ers (estimation uncertainties in the audit and failure to
∙ Examples using the Caseware IDEA software have been
make informative disclosures); and Scott London, KPMG
added in Chapters 3, 4, 5, 7, 8, 9, Module F, and Module
Partner (failure of auditor to follow the AICPA Code of
G. In addition, end-of-chapter exercises using author-
Conduct).
developed databases exclusively for use with Auditing &
xiv
Auditing & Assurance Services
xv
∙ Updated PCAOB inspection findings through the latest ∙ Added a new Auditing Insight regarding Verizon’s pur-
inspection reports. chases, including the recent proposed purchase of Yahoo!
∙ Includes a focus on data and analytics that inte- ∙ Added a new Auditing Insight describing off-
grates several IDEA exercises, including new author- balance-sheet risk for Citigroup.
created content and end-of-chapter materials. ∙ Expanded discussion of auditing accounting estimates and
fair values, with discussion of extreme estimation uncertainty
CHAPTER 8: Acquisition and Expenditure Cycle and an Auditing Insight on the Lehman Brothers collapse.
∙ Added a discussion of blockchain technology and Bitcoin
∙ Revised format tracking the audit process beginning with
transactions.
identification of significant accounts and relevant assertions.
∙ Updated PCAOB inspection findings through the latest
∙ Added five new tables outlining risks and tracking them
inspection reports.
through the audit process, including tests of controls and
substantive procedures.
CHAPTER 11: Completing the Audit
∙ Increased discussion of risks related to accounts payable.
∙ Updated PCAOB inspection findings through the latest ∙ New introductory vignette discusses Valeant’s year-end
inspection reports. financial troubles and the effect on the auditors trying to
∙ Includes a focus on data and analytics that inte- complete the company’s audit. Added discussion of AS
grates several IDEA exercises, including new author- 16’s increased responsibilities to communicate with those
created content and end-of-chapter materials. charged with governance.
CHAPTER 12: Reports on Audited Financial
CHAPTER 9: Production Cycle Statements
∙ Revised format tracking the audit process beginning ∙ New introductory vignette discusses KPMG’s report on
with identification of significant accounts and relevant the audit of Rolls-Royce and the identification of critical
assertions. audit matters in this report.
∙ Added six new tables outlining risks and tracking them ∙ Discuss recently approved and proposed standards of
through the audit process, including tests of controls and audit report disclosures and practices related to critical
substantive procedures. audit matters, naming of the engagement partner, and
∙ Extensive discussion of the production process and key audits of group financial statements.
reports of interest to the auditors. ∙ Summarize recent academic research related to the dis-
∙ Updated PCAOB inspection findings through the latest closure of critical audit matters, disclosure of engagement
inspection reports. partner identity, receipt and issuance of going concern
∙ Includes a focus on data and analytics that integrates sev- reports, and inclusion of explanatory paragraphs in other-
eral IDEA exercises, including new author-created con- wise unmodified audit opinions.
tent and end-of-chapter materials. ∙ Included examples from recent auditors’ reports of Abbott
Laboratories, Alaska Air, Best Buy Co. Inc., Caesars Enter-
tainment Corporation, The Coca-Cola Company, General
CHAPTER 10: Finance and Investment Cycle
Electric, Harris Teeter Supermarkets Inc., The Kroger Co.,
∙ Revised format tracking the audit process beginning with Penske Automotive Group, and Softbank Corp. to illustrate
identification of significant accounts and relevant assertions. how auditors modify their reports for situations encountered
∙ Added five new tables outlining risks and tracking them in practice.
through the audit process, including tests of controls and ∙ Include results of an Audit Analytics research report sum-
substantive procedures. marizing 15 years of data regarding going-concern reports.
xvi
MODULE B: Professional Ethics of attributes sampling in the audit engagement to place
the attributes sampling process in context.
∙ Opened the module with the story of disgraced former
∙ IDEA is used in the determination of sample size, selec-
KPMG partner Scott London who sacrificed his career to
tion of sample items, and evaluation of sample results to
share confidential client information with a friend.
supplement the use of AICPA sampling tables.
∙ Added a discussion of Aristotelian virtue ethics to already
∙ Additional end-of-chapter items provide students with the
existing discussions of Kantian categorical imperatives
opportunity to use IDEA in various stages of the attributes
and utilitarianism.
sampling process.
∙ Added a discussion of the role of the PCAOB’s Division
∙ Summarized a recent academic study that surveyed the
of Enforcement and Investigations.
sampling practices of six international accounting firms
with respect to establishing parameters and selecting sam-
MODULE C: Legal Liability ple items.
∙ Updated the introductory vignette on litigation involving
BDO Seidman for its audits of E.S. Bankest to include the MODULE G: Variables Sampling
ultimate resolution of this litigation.
∙ Updated the summary of major settlements involving Big ∙ Introductory section provides an overview of the audit
Four accounting firms to include settlements occurring engagement, the use of the audit risk model, and the role
since 2008. of variables sampling in the audit engagement to place the
variables sampling process in context.
∙ Expanded the discussion of academic research examining
auditor litigation to include recent studies that investigated ∙ IDEA is used in the determination of sample size, selec-
the factors affecting the litigation risk faced by audit firms. tion of sample items, and evaluation of sample results to
supplement the use of formulae in MUS.
MODULE D: Internal Audits, Governmental Audits, ∙ Additional end-of-chapter items to provide students with
and Fraud Examinations the opportunity to use IDEA in various stages of MUS
applications.
∙ Updated the coverage of the reliance of Congress on the ∙ Auditing Insight summarize the results of a recent aca-
GAO. demic study that surveyed the sampling practices of six
∙ Discussed the variety of services provided by internal international accounting firms.
auditors. ∙ Previous content on classical variables sampling and
∙ Added Benford’s law to the fraud investigation discussion. nonstatistical sampling has been expanded and relocated
into appendixes to provide instructors with flexibility in
MODULE E: Overview of Sampling addressing these topics.
∙ New introductory vignette involve the recent U.S.
Supreme Court ruling on use of sampling methods to MODULE H: Auditing and Information Technology
determine monetary damages against Tyson Foods in an
∙ Significantly revised (and simplified) the module
employment dispute.
throughout to reinforce how the client’s use of auto-
∙ Revised walk-through example of the use of sampling to mated transaction processing systems affects the major
address a nonauditing issue. stages of the audit team’s study and evaluation of inter-
∙ Auditing Insight addresse how sampling risk affected pre- nal control.
dictions in the 2015 United Kingdom general elections for ∙ Provided an example of how students encounter IT gen-
David Cameron and the Conservative Party. eral and app controls when using a smartphone.
∙ Included a brief example of sampling in the evaluation of ∙ Added additional end-of-chapter material that requires
internal control to illustrate the major steps and decisions students to identify tests of controls that would be used to
made in the sampling process. evaluate the operating effectiveness of general and auto-
mated application controls.
MODULE F: Attributes Sampling
∙ Introductory section provide an overview of the audit
engagement, the use of the audit risk model, and the role
xvii
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Acknowledgments
OUR SINCEREST THANKS . . .
The American Institute of Certified Public Accountants (AICPA) has generously given
permission for liberal quotations from official pronouncements and other AICPA publi-
cations, all of which lend authoritative sources to the text. In addition, several publish-
ing houses, professional associations, and accounting firms have granted permission to
quote and extract from their copyrighted material. Their cooperation is much appreci-
ated because a great amount of significant auditing thought exists in this wide variety
of sources.
A special acknowledgment is due to the Association for Certified Fraud Examiners
(ACFE). It has been a generous contributor to the fraud auditing material in this text. The
authors also acknowledge the valuable inclusion of the educational version of IDEA software
in the seventh edition, which significantly enhances the practical application of the book.
Also, the authors are particularly grateful to Meghann Cefaratti (Northern Illinois
University), Brad Roof (James Madison University), and Yigal Rechtman (Pace University)
for their many insightful comments over the past several years. The feedback they con-
tributed while teaching from our text has contributed greatly to the clarity and accuracy
of subsequent editions. A special thanks to Michael K. Shaub for his valuable critique of
Chapter 5 and to Steven Dwyer, Suzanne McLaughlin, and Frank Wimer for the example
developed to help explain the difference between general and application controls in
Module H. Thanks to Helen Roybark for her help with the preparation of the instructor
PowerPoint presentations.
We are sincerely grateful for the valuable input of all those who helped guide our
developmental decisions for the past seven editions of Auditing & Assurance Services:
xx
Acknowledgments xxi
Few understand the enormous commitment of time and energy that it takes to put
together a textbook. As authors, we are constantly scanning The Wall Street Journal and
other news outlets for real-world examples to illustrate theoretical discussions, reread-
ing and rewriting each other’s work to make sure that key concepts are understandable,
and double-checking our solutions to end-of-chapter problems. Among the few who do
understand the time and energy commitment are our family members (Barbara Louwers;
Kristin, Jackson, Elijah, Jonah, Ansley, and Laney Grace Blay; Karen, Matthew, Joshua,
and Adam Sinason; Susan and Meghan Strawser; and Ellen, Jenny, Eric, and Jessica
Thibodeau) who uncomplainingly endured endless refrains of, “I just need a couple more
minutes to finish this section.” Words cannot express our gratitude to each of them for
their patience and unending support.
Tim Louwers
Allen Blay
Dave Sinason
Jerry Strawser
Jay Thibodeau
Brief Contents
PART ONE PART THREE
The Contemporary Auditing Environment Stand-Alone Modules
1. Auditing and Assurance Services 1 Please refer to pages xviii–xxiii for guidance
on when to best integrate these modules.
2. Professional Standards 40
A. Other Public Accounting Services 583
PART TWO B. Professional Ethics 628
The Financial Statement Audit C. Legal Liability 676
3. Engagement Planning 75 D. Internal Audits, Governmental Audits, and
4. Management Fraud and Audit Risk 117 Fraud Examinations 720
xxiv
Contents
PART ONE Chapter 2
THE CONTEMPORARY AUDITING Professional Standards 40
ENVIRONMENT Introduction 41
Generally Accepted Auditing Standards (GAAS) 42
Chapter 1 Fundamental Principle: Responsibilities 45
Auditing and Assurance Services 1 Fundamental Principle: Performance 48
Fundamental Principle: Reporting 54
User Demand for Reliable Information 2 Evaluating the Quality of Public Accounting Firms’
Information Risk in a Big Data World 3 Practices 56
Auditing, Attestation, and Assurance System of Quality Control 56
Services 4 PCAOB Inspection of Firms 58
Definition of Financial Statement Auditing 5 Summary 60
Auditing in a Big Data Environment 6 Key Terms 61
Attestation Engagements 7 Multiple-Choice Questions for Practice and
Assurance Services 9 Review 63
Examples of Assurance Services 10 Exercises and Problems 66
Management’s Financial Statement Assertions 12 Appendix 2A
Existence or Occurrence (Existence, Occurrence) 13
Rights and Obligations
Referencing Professional Standards 73
(Rights and Obligations) 14
Completeness (Completeness, Cutoff) 15
Valuation and Allocation (Accuracy or PART TWO
Valuation) 15 THE FINANCIAL STATEMENT AUDIT
Presentation and Disclosure (Classification,
Understandability) 15 Chapter 3
Importance of Assertions 17
Engagement Planning 75
Professional Skepticism 18
Public Accounting 21 Introduction 76
Assurance Services 21 Pre-Engagement Activities (AU-C 300, AS 2101) 77
Tax Services 23 Client Acceptance or Continuance 77
Consulting and Advisory Services 23 Compliance with Independence and Ethical
Other Kinds of Engagements and Information Requirements 79
Professionals 24 Engagement Letters 80
Internal Auditing 24 Audit Plan (AU-C 300, AS 2101) 82
Governmental Auditing 25 Staffing the Audit Engagement 83
Regulatory Auditors 26 Considering the Work of Internal Auditors
Become a Professional and Get Certified! 26 (AU-C 610, AS 2605) 84
Education 27 Using the Work of an Audit Specialist
Examination 27 (AU-C 620, AS 1210) 85
Experience 28 Use of IT Auditors 85
State Certificate and License 29 Time Budget 85
Skill Sets and Your Education 30 Materiality (AU-C 320, AS 2105) 87
Summary 31 Materiality Calculation 89
Key Terms 31 Audit Procedures for Obtaining Audit
Multiple-Choice Questions for Practice and Evidence (AU-C 500, AS 1105) 90
Review 32 1. Inspection of Records and Documents 93
Exercises and Problems 37 2. Inspection of Tangible Assets 96
xxv
xxvi Contents
Chapter 4 Appendix 4B
Sample Audit Memorandum 170
Management Fraud and Audit Risk 117
Introduction 118
Audit Risk (AU 320, AS 1101) 119 Chapter 5
Audit Risk 119
Risk Assessment: Internal Control
Inherent Risk 120
Control Risk 120
Evaluation 173
Detection Risk 120 Introduction 174
Audit Risk Model 120 Internal Control Defined 175
Fraud Risk (AU-C 240, AS 2401) 124 Management Versus Auditors’ Responsibility for
Fraud 126 Internal Control 176
Types of Fraud 128 Auditors’ Internal Control Responsibilities 176
128
Other Definitions Related to Fraud Components of Internal Control 179
Inherent Risk Assessment—“What Could Go Control Environment 180
Wrong?” (AU 315, AS 2110) 130 Risk Assessment 181
Understanding the Client’s Business and Control Activities 183
Its Environment 132 Information and Communication 187
Industry, Regulatory, and Other External Factors 132 Monitoring 188
The Nature of the Company 133 Limitations of Internal Control 190
Related Parties 133 Internal Control Evaluation 191
Selection and Application of Accounting Principles, Phase 1: Understand and Document the Client’s Internal
Including Related Disclosures 134 Control 192
Company Objectives, Strategies, and Related Business Phase 2: Assess the Control Risk (Preliminary) 197
Risks 135 Phase 3: Identify Controls to Test and Perform Tests of
Company Performance Measures 137 Controls 199
Gathering Information and Preliminary Analytical Responsibilities in Public Company Audits Required
Procedures 137 by PCAOB Auditing Standard No. 2201 203
General Business Sources 137 Requirements 204
Company Sources 138 Internal Control Communications 207
Information from Client Acceptance or Continuance Summary 208
Evaluation, Audit Planning, Past Audits, and Other Key Terms 209
Engagements 138 Multiple-Choice Questions for Practice and
Preliminary Analytical Procedures Review 210
(AU 520, AS 2110) 138 Exercises and Problems 214
Audit Team Brainstorming Discussions 144 Appendix 5A
Contents xxvii
Completing Substantive Procedures 504 Multiple-Choice Questions for Practice and Review 567
Attorney Letters 505 Exercises and Problems 569
Written Representations 509
Ability to Continue as a Going Concern 512
Adjusting Entries and Financial Statement PART THREE
Disclosure 513 STAND-ALONE MODULES
Audit Documentation Review 516
Subsequent Events and Subsequently Module A
Discovered Facts 517
Subsequent Events 517
Other Public Accounting Services 583
Subsequently Discovered Facts 519 Introduction 585
Responsibilities Following the Audit Attestation Engagements 585
Report Release Date 521 Introduction to Attestation Engagements 585
Omitted Procedures 521 Applying Agreed-Upon Procedures 588
Communications with Individuals Charged with Prospective Financial Information and Pro Forma
Governance 521 Financial Information 588
Management Letter 523 An Examination of an Entity’s Internal Control over
Summary of Audit Communications 523 Financial Reporting That Is Integrated with an Audit
Summary 524 of Its Financial Statements (AT 501) 590
Key Terms 524 Compliance Attestation 591
Multiple-Choice Questions for Practice and Broker–Dealer Compliance 592
Review 525 Management’s Discussion and Analysis 594
Exercises and Problems 528 Service Organizations 594
Unaudited Financial Statements: Reviews,
Chapter 12 Compilations, and Preparation Engagements 598
Review Services 598
Reports on Audited Financial Compilation Services 602
Statements 540 Preparation of Financial Statements 603
Introduction 541 Summary of Audits, Reviews, and Compilations 604
Overview of Auditors’ Reports 542 Responsibilities Related to Reporting on Interim
The Standard Report 543 Financial Information 604
Auditors’ Reports for Public Entities 544 Other Topics: Special and Restricted-Use
Types of Opinions 546 Reports 606
Conditions That Require Modifications to Specified Elements, Accounts, or Items 606
the Auditors’ Standard (Unmodified) Special-Purpose Frameworks 607
Report 547 Reports on Application of Requirements of an Appropriate
Departures from GAAP 547 Financial Reporting Framework 609
Scope Limitations 549 Assurance Services 611
Audits of Group Financial Statements 553 Why Develop New Assurance Services? 611
Auditors’ Reports Referencing Other Matters Definition: Assurance Services 612
Encountered During the Audit 556 eXtensible Business Reporting Language (XBRL) 613
Consistency 556 Enhanced Business Reporting 613
“Going-Concern” Uncertainties 556 Integrated Reporting 613
Other Information Accompanying Audited Trust Services 614
Financial Statements 557 Sustainability Reporting 615
Required Supplementary Information 558 Summary 616
Other Modifications 559 Key Terms 617
Summary: Emphasis-of-Matter and Other- Multiple-Choice Questions for Practice and
Matter Paragraphs 559 Review 618
Other Reporting Topics 560 Exercises and Problems 621
Comparative Financial Statements 560
Summary Financial Statements 562 Module B
Supplementary Information 563
Professional Ethics 628
Disclaimers of Opinion 563
Summary 564 Introduction 629
Key Terms 566 General Ethics 630
xxx Contents
An Ethical Decision Process 631 Auditors’ Defenses under the Securities Act 689
Philosophical Principles in Ethics 632 Section 13: Statute of Limitations 690
The Imperative Principle 632 Section 17: Antifraud 690
The Principle of Utilitarianism (or Section 24: Criminal Liability 690
Consequentialism) 634 The Securities Exchange Act of 1934
The Generalization Argument 634 (Securities Exchange Act) 691
Virtue Ethics 634 Section 10 and Rule 10(b)-5: Antifraud 691
Ethical Codes of Conduct 635 Section 18: Civil Liability 693
U.S. Securities and Exchange Commission (SEC) 636 Auditors’ Defenses under the Securities Exchange Act 693
The Public Company Accounting Oversight Board Section 32: Criminal Liability 694
(PCAOB) 636 Foreign Corrupt Practices Act (FCPA) 694
The International Federation of Accountants (IFAC) 636 Summary of Auditors’ Liability to Clients and
The Professional Ethics Executive Committee (PEEC) of Third Parties 695
the American Institute of CPAs (AICPA) 637 The Changing Landscape of Auditors’ Liability 697
An Emphasis on Independence 639 Sarbanes–Oxley 697
American Institute of Certified Public Accountants 639 Racketeer Influenced and Corrupt Organizations Act 698
SEC and PCAOB Independence Rules 646 Aiding and Abetting 699
Other Effects of Sarbanes–Oxley on Auditor Organization of Accounting Firms as
Independence 648 Limited Liability Partnerships 699
Government Accountability Office (GAO) Independence Proportionate Liability 700
Requirements 649 Class-Action Suits 700
AICPA Rules of Conduct: Integrity and Auditors’ Liability Caps 702
Objectivity, Responsibilities to Clients, and Other Other Developments 702
Responsibilities 650 Summary 703
Integrity and Objectivity Rule 650 Key Terms 704
General Standards Rule 652 Multiple-Choice Questions for Practice and
Compliance with Standards Rule 651 Review 705
Accounting Principles Rule 652 Exercises and Problems 710
Confidential Client Information Rule 652
Fees and Other Types of Remuneration 654 Module D
Acts Discreditable Rule 656 Internal Audits, Governmental Audits,
Advertising and Other Forms of Solicitation Rule 657
and Fraud Examinations 720
Form of Organization and Name Rule 658
The International Ethics Standards Board for Introduction 721
Accountants (IESBA) Code 659 “External,” Governmental, and Internal Audits 722
Consequences of Violating the Code of Internal Audits 723
Professional Conduct 659 Independence 723
Self-Regulatory Discipline 659 Value-Added Audit 725
Public Regulation Discipline 660 Scope of Service 726
Summary 662 Internal Audit Standards 730
Key Terms 663 Internal Audit Reports 731
Multiple-Choice Questions for Practice and Governmental Audits 732
Review 663 Types of Governmental Audits 734
Exercises and Problems 667 Audit Procedures—Economy, Efficiency, and
Program Results Audits 735
Module C GAO Government Auditing Standards 737
Single Audit Act of 1984 and Amendments of 1996 738
Legal Liability 676
GAO Audit Reports 739
The Legal Environment 678 Fraud Examinations 741
Liability Under Common Law 680 The Art of Fraud Examinations 743
Liability to Clients 680 Fraud Examiner Responsibilities 745
Liability to Third Parties 681 Building a Fraud Case 747
Liability for Compilation and Review Services 686 Protecting the Evidence 747
Liability Under Statutory Law 687 Obtaining Litigation Support 747
The Securities Act of 1933 (Securities Act) 688 Summary 747
Section 11: Civil Liability 688 Key Terms 749
Contents xxxi
Auditing and
Assurance Services
1001, 1005,
Overall Objectives of the Independent Auditor 200 1010, 1015
Consideration of Fraud in a Financial Statement Audit 240 2401
Audit Evidence 500 1105
Attestation Standards AT 101 AT 101
Compliance Auditing Considerations in Audits of Recipients of Governmental Financial Assistance 935 6110
1
2 Part One The Contemporary Auditing Environment
LO 1-4 Define professional skepticism and explain LO 1-6 Describe the audits and auditors in
its key characteristics. governmental, internal, and operational
LO 1-5 Describe the organization of public auditing.
accounting firms and identify the various LO 1-7 List and explain the requirements for becom-
services that they offer. ing a certified public accountant (CPA) and
other certifications available to an account-
ing professional.
In July 2015, the PCAOB released a concept statement that detailed results, focused on measures such as number of client restatements
28 different indicators of audit quality. The indicators were cat- and client frauds. The list is a clear indication to students that qual-
egorized within three broad categories. The first category, audit ity matters more than anything else in their future work as auditing
professionals, focused on measures such as partner workload and professionals.
industry expertise of professionals. The second category, audit pro- Source: PCAOB Concept Release on Audit Quality Indicators: Release
cess, focused on measures such as compliance with independence No.2015-005, July 1, 2015. Available at http://pcaobus.org/Rules/Rulemaking/
requirements and PCOAB inspection results. The third category, audit Docket%20041/Release_2015_005.pdf.
Why is audit quality so important? Well, both investors and creditors depend on
reliable financial statement information to make their investment and lending decisions
about a company. As a result, the confidence of investors and creditors is shaken each
and every time that audit quality is compromised. In fact, before we think about audit
quality any further, we must first explain the vital role that financial statement auditors
play in supplying key decision makers with useful, understandable, and timely infor-
mation. When you have a better understanding of why auditing is so critical to help
ensure the liquidity of the world’s capital markets, we will then explore in detail the
process auditors take to help ensure that audit quality is achieved. Because many of you
are likely planning to enter the public accounting profession and work as an auditor, we
hope that you will work hard to acquire this knowledge so that you may do your part in
playing a key role in maintaining the public’s confidence in both the auditing profes-
sion and the capital markets.
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DANCE ON STILTS AT THE GIRLS’ UNYAGO, NIUCHI
I see increasing reason to believe that the view formed some time
back as to the origin of the Makonde bush is the correct one. I have
no doubt that it is not a natural product, but the result of human
occupation. Those parts of the high country where man—as a very
slight amount of practice enables the eye to perceive at once—has not
yet penetrated with axe and hoe, are still occupied by a splendid
timber forest quite able to sustain a comparison with our mixed
forests in Germany. But wherever man has once built his hut or tilled
his field, this horrible bush springs up. Every phase of this process
may be seen in the course of a couple of hours’ walk along the main
road. From the bush to right or left, one hears the sound of the axe—
not from one spot only, but from several directions at once. A few
steps further on, we can see what is taking place. The brush has been
cut down and piled up in heaps to the height of a yard or more,
between which the trunks of the large trees stand up like the last
pillars of a magnificent ruined building. These, too, present a
melancholy spectacle: the destructive Makonde have ringed them—
cut a broad strip of bark all round to ensure their dying off—and also
piled up pyramids of brush round them. Father and son, mother and
son-in-law, are chopping away perseveringly in the background—too
busy, almost, to look round at the white stranger, who usually excites
so much interest. If you pass by the same place a week later, the piles
of brushwood have disappeared and a thick layer of ashes has taken
the place of the green forest. The large trees stretch their
smouldering trunks and branches in dumb accusation to heaven—if
they have not already fallen and been more or less reduced to ashes,
perhaps only showing as a white stripe on the dark ground.
This work of destruction is carried out by the Makonde alike on the
virgin forest and on the bush which has sprung up on sites already
cultivated and deserted. In the second case they are saved the trouble
of burning the large trees, these being entirely absent in the
secondary bush.
After burning this piece of forest ground and loosening it with the
hoe, the native sows his corn and plants his vegetables. All over the
country, he goes in for bed-culture, which requires, and, in fact,
receives, the most careful attention. Weeds are nowhere tolerated in
the south of German East Africa. The crops may fail on the plains,
where droughts are frequent, but never on the plateau with its
abundant rains and heavy dews. Its fortunate inhabitants even have
the satisfaction of seeing the proud Wayao and Wamakua working
for them as labourers, driven by hunger to serve where they were
accustomed to rule.
But the light, sandy soil is soon exhausted, and would yield no
harvest the second year if cultivated twice running. This fact has
been familiar to the native for ages; consequently he provides in
time, and, while his crop is growing, prepares the next plot with axe
and firebrand. Next year he plants this with his various crops and
lets the first piece lie fallow. For a short time it remains waste and
desolate; then nature steps in to repair the destruction wrought by
man; a thousand new growths spring out of the exhausted soil, and
even the old stumps put forth fresh shoots. Next year the new growth
is up to one’s knees, and in a few years more it is that terrible,
impenetrable bush, which maintains its position till the black
occupier of the land has made the round of all the available sites and
come back to his starting point.
The Makonde are, body and soul, so to speak, one with this bush.
According to my Yao informants, indeed, their name means nothing
else but “bush people.” Their own tradition says that they have been
settled up here for a very long time, but to my surprise they laid great
stress on an original immigration. Their old homes were in the
south-east, near Mikindani and the mouth of the Rovuma, whence
their peaceful forefathers were driven by the continual raids of the
Sakalavas from Madagascar and the warlike Shirazis[47] of the coast,
to take refuge on the almost inaccessible plateau. I have studied
African ethnology for twenty years, but the fact that changes of
population in this apparently quiet and peaceable corner of the earth
could have been occasioned by outside enterprises taking place on
the high seas, was completely new to me. It is, no doubt, however,
correct.
The charming tribal legend of the Makonde—besides informing us
of other interesting matters—explains why they have to live in the
thickest of the bush and a long way from the edge of the plateau,
instead of making their permanent homes beside the purling brooks
and springs of the low country.
“The place where the tribe originated is Mahuta, on the southern
side of the plateau towards the Rovuma, where of old time there was
nothing but thick bush. Out of this bush came a man who never
washed himself or shaved his head, and who ate and drank but little.
He went out and made a human figure from the wood of a tree
growing in the open country, which he took home to his abode in the
bush and there set it upright. In the night this image came to life and
was a woman. The man and woman went down together to the
Rovuma to wash themselves. Here the woman gave birth to a still-
born child. They left that place and passed over the high land into the
valley of the Mbemkuru, where the woman had another child, which
was also born dead. Then they returned to the high bush country of
Mahuta, where the third child was born, which lived and grew up. In
course of time, the couple had many more children, and called
themselves Wamatanda. These were the ancestral stock of the
Makonde, also called Wamakonde,[48] i.e., aborigines. Their
forefather, the man from the bush, gave his children the command to
bury their dead upright, in memory of the mother of their race who
was cut out of wood and awoke to life when standing upright. He also
warned them against settling in the valleys and near large streams,
for sickness and death dwelt there. They were to make it a rule to
have their huts at least an hour’s walk from the nearest watering-
place; then their children would thrive and escape illness.”
The explanation of the name Makonde given by my informants is
somewhat different from that contained in the above legend, which I
extract from a little book (small, but packed with information), by
Pater Adams, entitled Lindi und sein Hinterland. Otherwise, my
results agree exactly with the statements of the legend. Washing?
Hapana—there is no such thing. Why should they do so? As it is, the
supply of water scarcely suffices for cooking and drinking; other
people do not wash, so why should the Makonde distinguish himself
by such needless eccentricity? As for shaving the head, the short,
woolly crop scarcely needs it,[49] so the second ancestral precept is
likewise easy enough to follow. Beyond this, however, there is
nothing ridiculous in the ancestor’s advice. I have obtained from
various local artists a fairly large number of figures carved in wood,
ranging from fifteen to twenty-three inches in height, and
representing women belonging to the great group of the Mavia,
Makonde, and Matambwe tribes. The carving is remarkably well
done and renders the female type with great accuracy, especially the
keloid ornamentation, to be described later on. As to the object and
meaning of their works the sculptors either could or (more probably)
would tell me nothing, and I was forced to content myself with the
scanty information vouchsafed by one man, who said that the figures
were merely intended to represent the nembo—the artificial
deformations of pelele, ear-discs, and keloids. The legend recorded
by Pater Adams places these figures in a new light. They must surely
be more than mere dolls; and we may even venture to assume that
they are—though the majority of present-day Makonde are probably
unaware of the fact—representations of the tribal ancestress.
The references in the legend to the descent from Mahuta to the
Rovuma, and to a journey across the highlands into the Mbekuru
valley, undoubtedly indicate the previous history of the tribe, the
travels of the ancestral pair typifying the migrations of their
descendants. The descent to the neighbouring Rovuma valley, with
its extraordinary fertility and great abundance of game, is intelligible
at a glance—but the crossing of the Lukuledi depression, the ascent
to the Rondo Plateau and the descent to the Mbemkuru, also lie
within the bounds of probability, for all these districts have exactly
the same character as the extreme south. Now, however, comes a
point of especial interest for our bacteriological age. The primitive
Makonde did not enjoy their lives in the marshy river-valleys.
Disease raged among them, and many died. It was only after they
had returned to their original home near Mahuta, that the health
conditions of these people improved. We are very apt to think of the
African as a stupid person whose ignorance of nature is only equalled
by his fear of it, and who looks on all mishaps as caused by evil
spirits and malignant natural powers. It is much more correct to
assume in this case that the people very early learnt to distinguish
districts infested with malaria from those where it is absent.
This knowledge is crystallized in the
ancestral warning against settling in the
valleys and near the great waters, the
dwelling-places of disease and death. At the
same time, for security against the hostile
Mavia south of the Rovuma, it was enacted
that every settlement must be not less than a
certain distance from the southern edge of the
plateau. Such in fact is their mode of life at the
present day. It is not such a bad one, and
certainly they are both safer and more
comfortable than the Makua, the recent
intruders from the south, who have made USUAL METHOD OF
good their footing on the western edge of the CLOSING HUT-DOOR
plateau, extending over a fairly wide belt of
country. Neither Makua nor Makonde show in their dwellings
anything of the size and comeliness of the Yao houses in the plain,
especially at Masasi, Chingulungulu and Zuza’s. Jumbe Chauro, a
Makonde hamlet not far from Newala, on the road to Mahuta, is the
most important settlement of the tribe I have yet seen, and has fairly
spacious huts. But how slovenly is their construction compared with
the palatial residences of the elephant-hunters living in the plain.
The roofs are still more untidy than in the general run of huts during
the dry season, the walls show here and there the scanty beginnings
or the lamentable remains of the mud plastering, and the interior is a
veritable dog-kennel; dirt, dust and disorder everywhere. A few huts
only show any attempt at division into rooms, and this consists
merely of very roughly-made bamboo partitions. In one point alone
have I noticed any indication of progress—in the method of fastening
the door. Houses all over the south are secured in a simple but
ingenious manner. The door consists of a set of stout pieces of wood
or bamboo, tied with bark-string to two cross-pieces, and moving in
two grooves round one of the door-posts, so as to open inwards. If
the owner wishes to leave home, he takes two logs as thick as a man’s
upper arm and about a yard long. One of these is placed obliquely
against the middle of the door from the inside, so as to form an angle
of from 60° to 75° with the ground. He then places the second piece
horizontally across the first, pressing it downward with all his might.
It is kept in place by two strong posts planted in the ground a few
inches inside the door. This fastening is absolutely safe, but of course
cannot be applied to both doors at once, otherwise how could the
owner leave or enter his house? I have not yet succeeded in finding
out how the back door is fastened.