Confirming Pages

EIGHTH EDITION

Auditing & Assurance

Services A S Y S T E M A T I C A P P R O A C H

William F. Messier, Jr.

University of Nevada, Las Vegas
Department of Accounting
and
Norwegian School of Economics
and Business Administration
Department of Accounting, Auditing and Law

Steven M. Glover
Brigham Young University
Marriott School of Management
School of Accountancy

Douglas F. Prawitt
Brigham Young University
Marriott School of Management
School of Accountancy

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AUDITING AND ASSURANCE SERVICES: A SYSTEMATIC APPROACH

Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY, 10020.
Copyright © 2012, 2010, 2008, 2008, 2006, 2003, 2000, 1997 by The McGraw-Hill Companies, Inc. All rights reserved. Printed in the United
States of America. 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 The McGraw-Hill Companies, Inc., 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.

1 2 3 4 5 6 7 8 9 0 DOW/DOW 1 0 9 8 7 6 5 4 3 2 1

ISBN 978-0-07-802543-3
MHID 0-07-802543-5

Vice president and editor-in-chief: Brent Gordon

Publisher: Tim Vertovec
Sponsoring editor: Donna Dillon
Executive director of development: Ann Torbert
Development editor II: Katie Jones
Editorial coordinator: Jessica Wiley
Vice president of marketing: Robin J. Zwettler
Marketing director: Brad Parkins
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Typeface: 10/12 New Aster
Compositor: Laserwords Private Limited
Printer: R. R. Donnelley

Library of Congress Cataloging-in-Publication Data

Messier, William F.
Auditing & assurance services : a systematic approach / William F. Messier, Jr., Steven M.
Glover, Douglas F. Prawitt. —8th ed.
p. cm.
Includes index.
ISBN-13: 978-0-07-802543-3 (alk. paper)
ISBN-10: 0-07-802543-5 (alk. paper)
1. Auditing. I. Glover, Steven M., 1963- II. Prawitt, Douglas F. III. Title.
IV. Title: Auditing and assurance services.
HF5667.M46 2012
657'.45—dc23
2011027066

www.mhhe.com

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 Confirming Pages

The authors dedicate this book to the

following individuals:

Teddie, Stacy, Mark, Bob, Brandon,

and Zachary
—William F. Messier, Jr.

Tina, Jessica, Andrew, Jennifer, Anna,

Wayne, and Penny
—Steven M. Glover

Meryll, Nathan, Matthew, Natalie, Emily, AnnaLisa,

Leah, George, and Diana
—Douglas F. Prawitt

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 Confirming Pages

Why a New Edition?

Dear Colleagues and Friends,

The events of the past decade have brought turmoil and change to the business world, and the
accounting profession has also been affected. The auditing environment is far more complex
today than it was even 10 years ago. Today, for example, financial statement auditors practice in
a regulated environment and must deal with three sets of auditing standards: the standards of
the PCAOB for audits of U.S. public companies, the standards of the AICPA’s Auditing Standards
Board for audits of essentially all other U.S. entities (e.g., private companies, government entities,
universities, etc.), and the standards of the IFAC’s International Auditing and Assurance Standards
Board for audits of entities based outside of the United States. It is difficult enough for you and for
us as professors to stay abreast of the unprecedented change and complexity in the auditing envi-
ronment. It is simply unrealistic to expect our students to be able to grasp all of this while they are
working diligently just to learn the fundamentals of financial statement auditing.

That is why we have worked very hard in this edition to present the fundamentals of auditing in a
crisp, clear, and understandable way, helping students navigate the inherent complexity while gain-
ing a deep, intuitive grasp of fundamental auditing concepts. We do this by using simple yet pow-
erful illustrations, examples, and analogies, such as relating the demand for an audit to the desire
of a prospective home buyer to hire a house inspector. In terms of the three sets of extant auditing
standards, we simplify the complexities involved by adopting an approach similar to that taken by
all of the major international accounting firms: we start with a base set of standards (the AICPA’s
new body of “clarity” standards) and we build on that base by addressing any requirements in the
PCAOB standards that demand more from the auditor. The AICPA’s clarity standards are newly
converged with international auditing standards, which means that by studying this book your stu-
dents will learn the auditing concepts that underlie an audit performed under any of the three extant
sets of standards. All of the major firms have adopted a similar approach because it allows their
professionals to practice effectively in any environment, domestic or international, using a single,
merged set of auditing principles, rather than having to learn the specifics of three different sets of
standards. Your students will have that same advantage in learning auditing from this book.

Although the auditing environment has become even more complex and demanding, at the
same time it is increasingly important that students gain a deep understanding and working
knowledge of fundamental auditing concepts and how they are applied. From the beginning
we have worked hard to make this book the most “student-friendly” introductory auditing
book on the market. Some of the ways this book encourages your students (and ours) to
think more clearly and deeply about what they are studying are by

(1) Introducing “stop and think” and “pause to test your intuition” phrases at key places
throughout the chapters to encourage students to more fully internalize key concepts.
(2) Clarifying explanations and adding easy-to-understand examples throughout the book.

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 Rev. Confirming Pages

(3) Making several chapters more concise and enhancing the focus on key concepts by deleting
noncentral detail. For example, Chapters 2–5 have been completely reorganized and rewritten
to improve clarity and flow.
(4) Improving end-of-chapter and supplementary materials throughout the book and on the
website.

This new edition also contains several important updates to reflect changes in auditing standards, such
as the PCAOB’s proposed Risk Assessment standards and the AICPA’s newly revised body of “clarity”
standards, including the “principles underlying an audit conducted in accordance with generally
accepted auditing standards.” Because of their increasing complexity and importance to the audit
process, this edition also includes discussions of auditing tax liability and auditing fair value measure-
ments. Plus, the book has been updated for the FASB’s new GAAP Codification. Finally, the authors
took a hands-on role in improving this edition’s test bank, online quizzes, instructor PowerPoint slides,
and the instructor’s manual.

While we are very much aware of the extra investment required when a book rolls to a new edition,
we believe that we owe it to our colleagues and students to provide the most up-to-date materials
possible so their hard work and energy in teaching and studying represents an investment in the
latest, most current concepts. We are confident that the changes made in this edition will make it
easier for you to teach effectively and for your students to learn more deeply and more efficiently.

Thank you for your support of this text and the many compliments we have received regarding past
editions. We are gratified by the enthusiastic response the text has received as we have done our best to
create a clear, easy-reading, student-friendly auditing textbook. We welcome your suggestions and hope
you will be pleased with the updates we have made in this new edition.

Warm regards,

William F. Messier, Jr. Steven M. Glover Douglas F. Prawitt

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About the Authors

William F. Messier, Jr. holds the Kenneth and Tracy Knauss Endowed Chair in Ac-
counting at the Department of Accounting, University of Nevada, Las Vegas. He is also
the PricewaterhouseCoopers Professor II at the Department of Accounting, Auditing
and Law at the Norwegian School of Economics and Business Administration. Profes-
sor Messier holds a B.B.A. from Siena College, an M.S. from Clarkson University, and
an M.B.A. and D.B.A. from Indiana University. He is a CPA in Florida and has held
faculty positions at the University of Florida (Price Waterhouse Professor) and Geor-
gia State University (Deloitte & Touche Professor). Professor Messier was a visiting
faculty member at SDA Bocconi in Milan and the University of Michigan. Professor
Messier served as the Academic Member of the AICPA’s Auditing Standards Board
and as Chair of the AICPA’s International Auditing Standards Subcommittee. He is
a past editor of Auditing: A Journal of Practice & Theory and formerly President of
the Auditing Section of the American Accounting Association. Professor Messier was
the recipient of the AAA Auditing Section’s Outstanding Educator Award (2009) and
the Distinguished Service in Auditing Award (2008). In 2011, Professor Messier was
awarded an honorary doctorate from the Norwegian School of Economics and Busi-
ness Administration. He has also served as an expert witness in audit litigation cases.
Professor Steven M. Glover is the Mary & Ellis Professor of Accounting at the
Marriott School of Management, Brigham Young University. Professor Glover is a
CPA in Utah and holds a PhD and BS from the University of Washington and an AA in
Business from BYU – Idaho. He previously worked as an auditor for KPMG LLP and
as a director in the national office of PwC LLP. Professor Glover serves on the audit
committee of a nonprofit organization and has served on the board of advisors for
technology companies and he actively consults with public companies and public ac-
counting firms. He has also served as an expert witness. Professor Glover is the Presi-
dent of the Auditing Section of the American Accounting Association. He has been on
auditing-related task forces of the AICPA. Professor Glover is on the editorial boards
of Auditing: A Journal of Practice & Theory, The Accounting Review, Current Issues in
Auditing, and Accounting Horizons. He has authored or coauthored over 30 articles
and books primarily focused in the areas of auditor decision making, audit education,
and audit practice. Most recently, together with Professor Doug Prawitt and KPMG,
LLP, he co-authored a ground-breaking monograph designed to accelerate the profes-
sional judgment of accounting and auditing students.
Professor Douglas F. Prawitt is the Glen Ardis Professor of Accountancy at
the Marriott School of Management, Brigham Young University. Professor Prawitt
is a CPA in Utah. He holds a PhD from the University of Arizona, and BS and MAcc
degrees from Brigham Young University. Professor Prawitt was awarded the Marriott
School’s Teaching Excellence and Outstanding Researcher awards in 1998 and
2000. He received the Merrill J. Bateman Student Choice Teaching Award in 2002
and BYU’s Wesley P. Lloyd Award for Distinction in Graduate Education in 2006.
He consults actively with international, regional, and local public accounting firms. He
worked extensively over a five-year period with the Committee of Sponsoring Organiza-
tions (COSO) on the COSO Enterprise Risk Management Framework and Internal Control
over Financial Reporting—Guidance for Smaller Public Companies projects, and served a
three-year appointment as a voting member of the AICPA Auditing Standards Board, from
2005–2008. In the fall of 2011, he was appointed to serve a three-year term on COSO’s
Board of Directors. Professor Prawitt has also served in several capacities with the Ameri-
can Accounting Association and is on the editorial boards of Auditing: A Journal of Practice
& Theory, Behavioral Research in Accounting, and Accounting Horizons. He has authored
or coauthored over 30 articles and books, primarily in the areas of auditor judgment and
decision making, audit education, and audit practice. Most recently, together with Pro-
fessor Steve Glover and KPMG, LLP, he co-authored a ground-breaking monograph de-
signed to accelerate the professional judgment of accounting and auditing students.
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Give your students an intuitive,

hands-on learning experience!

You want your students to develop a deep, intuitive under-

standing of auditing and to have a good experience in your
auditing class. So do we. The Messier, Glover, and Prawitt
text and complete learning and teaching package provide
the most intuitive, hands-on auditing textbook available for
you and your auditing students.

The 8th Edition includes the following important features and enhancements:
• “Stop and Think” and “Test your Intuition” phrases to encourage students to more fully
internalize key concepts
• The PCAOB’s new Risk Assessment Standards integrated throughout the book
• User-focused, user-friendly improvements
• Chapters 3–5 have been rearranged to provide a better presentation of audit planning
and the three major concepts that underlie auditing. Chapter 3 now starts with audit
planning, types of audit tests, and materiality. Chapter 4 focuses on risk assessment, and
Chapter 5 covers audit evidence and audit documentation.
• Increased use of Practice Insights that provide a link from the textbook material to the
real world.
• Hands-on cases that provide students with opportunities to apply audit procedures to
the EarthWear case.
• Clarifying meaning of technical business and accounting jargon
• Improved linkage between chapter content and end-of-chapter material
• References to auditing standards have been updated to reflect the new codification of
AICPA ASB clarity standards

Here is a sampling of the improvements made in this edition:

Chapter 1, An Introduction to Assurance and Financial Statement Auditing

• Updated for new auditing standards. Order of fundamental auditing concepts modi-
fied to mirror the more intuitive flow of revised Chapters 3–5

Chapter 2, The Financial Statement Auditing Environment

• Updated and rewritten to improve understandability and flow of concepts relating to the
various types of auditing and the environment in which auditing takes place
• Now includes AICPA’s “principles underlying an audit” in addition to PCAOB’s tradi-
tional set of “generally accepted auditing standards”

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viii Give Your Students an Intuitive, Hands-On Learning Experience!

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

• Clearer specification of the steps included in audit planning
• New section on auditing multiple locations and business units based on PCAOB Audit-
ing Standard No. 9
• New section on supervision of the audit based on PCAOB Auditing Standard No. 10

Chapter 4, Risk Assessment

• Updated to reflect the final PCAOB Risk Assessment Standards
• Improved presentation of the fraud risk assessment process

Chapter 5, Evidence and Documentation

• Updated to reflect the final PCAOB Risk Assessment Standards
• Revised Audit Module on the use of substantive analytical procedures

Chapter 6, Internal Control in a Financial Statement Audit

• Updated to reflect PCAOB Risk Assessment Standards
• Updated for new SAS on Audit Considerations Relating to a Client Using
a Service Organization

Chapter 7, Auditing Internal Control over Financial Reporting

• Updated to reflect PCAOB Risk Assessment Standards
• Revised to present material more concisely

Chapter 8, Audit Sampling: An Overview and Application to Tests of Controls

• Updated for changes in the new ASB clarity standard, AU 530, “Audit Sampling”
• Added a table comparing attribute sampling terms used in ACL with those associated
with the AICPA tables illustrated in the chapter

Chapter 9, Audit Sampling: An Application to Substantive Tests of Account Balances

• Updated for changes in the new ASB clarity standard, AU 530, “Audit Sampling”
• Added a table comparing terminology for MUS between ACL and manual calculation

Chapters 10–16, Business Process Chapters

• Revised for enhanced clarity and brevity
• Updated to recognize the elimination of “SAS 70” references as reports on controls of ser-
vice organizations is now addressed in AT 801
• Clarified illustrations linking assertions to possible misstatements to example controls
and tests of controls
• Updated exhibits and practice insights for recent events, for example, sanction of PwC
India in connection with the Satyam fraud
• Replaced Internet end-of-chapter problems requiring research on SEC actions with more
recent cases

Chapter 17, Completing the Audit Engagement

• Revised for greater conciseness and clarity, enhanced focus on key concepts
• Clarified discussion of auditor’s responsibility for subsequent events
• Enhanced discussion of the role of the quality review partner in ensuring engagement
quality

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Give Your Students an Intuitive, Hands-On Learning Experience! ix

Chapter 18, Reports on Audited Financial Statements

• Updated for recent developments including the new “clarified” form of the ASB audit
report

Chapter 19, Professional Conduct, Independence, and Quality Control

• Updated for changes in Code of Professional Conduct, with new examples of ethics vio-
lations
• Discussion of quality control and peer review/inspection updated for recent changes in
relevant standards

Chapter 20, Legal Liability

• Updated for important recent case and statutory law
• Included implications of the Dodd-Frank Act of 2010
• Enhanced legal liability information on the book’s website
• Updated legal case descriptions for new cases

Chapter 21, Assurance, Attestation, and Internal Auditing Services

• Updated standards relating to practitioner independence in compilation engagements
• Attestation reports updated for new AICPA standards

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How does 8e prepare students

The recent implosion of financial markets has had a significant effect on the auditing profession.
In this ever changing environment, it is crucial that students learn from the most up-to-date
resources. Once again, the author team of Auditing & Assurance Services: A Systematic Approach is
dedicated to providing the most current professional content and real-world application, as well as
helping students develop professional judgment and prepare for the CPA exam.

In their 8th edition, authors Messier, Glover, and Prawitt continue to reinforce the fundamental
values central to their past seven editions:

Student Engagement. The authors believe students are best served by acquiring a strong understanding
of the basic concepts that underlie the audit process and how to apply those concepts to various audit
and assurance services. The primary purpose for an auditing text is not to serve as a reference manual
but to facilitate student learning, and this text is written accordingly. The text is accessible to students
through straightforward writing and the use of engaging, relevant real-world examples, illustrations,
and analogies. The text explicitly encourages students to think through fundamental concepts and
to avoid trying to learn auditing through rote memorization. Students are prompted by the text to
“stop and think,” at important points in the text, in order to help them apply the principles covered.
Consistent with this aim, the text’s early chapters avoid immersing students in unnecessary detail,
focusing instead on students’ understanding of fundamental audit concepts. Additionally, the case
involving EarthWear Clothiers, a mail-order retailer, has been updated and integrated throughout
the book and the Online Learning Center and now also includes free student access to several
useful hands-on mini-cases, with full solutions available to the instructor. Finally, “practice insights”
throughout the book engage students and help them understand the practical nature of auditing.

A Systematic Approach. The text continues to take a systematic approach to the audit process by
first introducing the three underlying concepts: audit risk, materiality, and evidence. This is fol-
lowed by a discussion of audit planning, the assessment of control risk, and a discussion of the
nature, timing, and extent of evidence necessary to reach the appropriate level of detection risk.
These concepts are then applied to each major business process and related account balances using
a risk-based approach. The text has been revised to include the risk assessment process included in
the standards adopted by the Auditing Standards Board and the International Auditing and Assur-
ance Standards Board, as well as the PCAOB’s newly adopted Risk Assessment Standards.

Decision Making. In covering these important concepts and their applications, the book focuses on
critical judgments and decision-making processes followed by auditors. Much of auditing practice
involves the application of auditor judgment. If a student understands these basic concepts and
how to apply them to an audit engagement, he or she will be more effective in today’s dynamic
audit environment. Two of the authors of this textbook recently worked with KPMG to develop a
monograph designed to accelerate the development of professional judgment in students. A brief
overview of professional judgment is provided on the text website (www.mhhe.com/messier8e) that
you can assign as reading for your students as you see fit.
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for the accounting profession?

Real-World Integration and Hands-On Mini-Cases.

Mini EarthWear cases

New and improved “hands-on”
mini-cases are integrated throughout HANDS-ON CASES
the text, on the website Control Environment and Internal Control Documentation
Complete remaining sections of the EarthWear control environment and internal control questionnaires.
(www.mhhe.com/messier8e), and Visit the book’s Online Learning center at www.mhhe.com/messier8e to find a detailed description of the
case and to download required materials.
available in Connect Accounting,
EarthWear Online Tests of Controls (Part A)
giving your students the opportunity Complete controls testing on a sample of EarthWear voucher packets and judgmentally evaluate the
to actually do some common auditing results of the tests of controls. (In Part B of this mini-case you are asked to statistically quantify and
evaluate the results of tests of controls. Part B is described in Chapter 8.).
procedures. Visit the book’s Online Learning Center at www.mhhe.com/messier8e to find a detailed description of the
case and to download required materials.

Practice Insight Practice The nature of a client’s business can have a dramatic effect on the nature of the auditor’s work and
INSIGHT work environment. For example, an auditor working at a meat-packing client will have very different
Practice Insights in each chapter experiences from an auditor working at a banking client. Further, many auditors eventually specialize
in certain industries and acquire significant expertise in those industries. This expertise and spe-
highlight important and interesting cialization often leads to attractive employment opportunities as a member of management. Thus,
in choosing which firm (or which office of a large firm) at which to seek a job, new auditors are well
real-world trends and practices. advised to carefully consider whether the firm (or office) has a significant presence in the industries in
which the prospective auditor is most interested.

Free ACL software

The educational version of ACL www.mhhe.com/ Visit the book’s Online Learning Center for problem material to be completed using the ACL software
packaged with your new text.
messier8e
software is packaged for free with mes25435_ch06_183-223.indd
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8:13PM
PM

each new book. Once again, the

authors wrote chapter-specific ACL assignments and created Roger Company ACL files, all of which
are found on the text website at www.mhhe.com/messier8e. Exposing students to ACL allows them the
opportunity to work with real professional audit software.

CPA Exam Review.

Kaplan CPA Review
Simulations
Created exclusively for McGraw-Hill Audit Client Letter
textbooks, each CPA simulation demon- www.mhhe.com/
Topics to be covered in simulation:
• A demonstration of an understanding of the main purpose of such a described audit and how this
purpose should be communicated to the client in this letter
strates auditing concepts in a web-based messier8e
• A demonstration of an understanding of “significant deficiencies”, “material weaknesses”, and
mes25435_ch02_033-066.indd 66 27/05/11 7:15 PM
“internal control” and how these matters should be referred to in the client letter.
interface, identical to that used in the ac- To begin this simulation, visit the book’s Online Learning Center.

tual CPA Exam. The 8th edition includes

new Kaplan simulations that were updated to match the task-based approach of the CPA exam. In addi-
tion to providing essential practice, CPA simulations help students:
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mes25435_ch02_033-066.indd 45 27/05/11 7:15 PM

• prepare for the CPA Exam
• build professional skills
• stay current on best business practices
Simulations are identified in the end-of-chapter material for chapters 4–6, 8, 10, 17, and 19 and are
denoted by the Kaplan CPA logo. Simulations are accessible via the text website (www.mhhe.com/
messier8e).
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Technology
McGraw-Hill Connect™ out of class. You can select and use any asset that
enhances your lecture. The Connect Accounting
Accounting Instructor Library includes:
• Solutions Manual
Less Managing. More Teaching. Greater • Instructor’s Manual
Learning. • Instructor PowerPoints
Available for the first • Test Bank
time with Messier Audit- • EarthWear Minicase Solutions
ing & Assurance Services, • Solutions to ACL assignments
McGraw-Hill Connect™ • eBook version of the text
Accounting is an online
Student Library.
assignment and assessment solution that connects
• The Connect Accounting Student Library is
students with the tools and resources necessary to
the place for students to access additional
achieve success through faster learning, more effi-
resources, such as lectures, practice materials,
cient studying, and higher retention of knowledge.
an eBook and more.
Online Assignments
Student progress tracking. Connect Accounting
Connect Accounting helps students learn more
keeps instructors informed about how each stu-
efficiently by providing feedback and practice
dent, section, and class is performing, allowing for
material when and where they need it. Connect
more productive use of lecture and office hours.
Accounting grades homework automatically and
The progress-tracking function enables you to:
gives immediate feedback on any questions stu-
dents may have missed. • View scored work immediately and track indi-
vidual or group performance with assignment
Simple assignment management. With Connect and grade reports.
Accounting, creating assignments is easier than • Access an instant view of student or class per-
ever, so you can spend more time teaching and formance relative to learning objectives.
less time managing. The assignment management • Collect data and generate reports required
function enables you to: by many accreditation organizations, such as
• Create and deliver assignments easily with AACSB and AICPA.
selectable end-of-chapter questions, test bank
items, and EarthWear mini-cases. McGraw-Hill’s Connect Plus Accounting
• Streamline lesson planning, student progress McGraw-Hill reinvents the textbook learning
reporting, and assignment grading to make experience for the modern student with Connect
classroom management more efficient than ever. Plus Accounting, which provides seamless integra-
• Go paperless with the eBook and online sub- tion of the eBook and Connect Accounting. Con-
mission and grading of student assignments. nect Plus Accounting provides all of the Connect
• Have assignments scored automatically, giving Accounting features plus the following:
students immediate feedback on their work and • An integrated eBook, allowing for anytime,
comparisons with correct answers. anywhere access to the textbook.
• Access and review each response; manually • Dynamic links between the problems or ques-
change grades or leave comments for students tions you assign to your students and the
to review. location in the eBook where that problem or
• Reinforce classroom concepts with Interactive question is covered.
Applications and practice quizzes. • A powerful search function to pinpoint and
connect key concepts in a snap.
Instructor Library. The Connect Accounting In-
structor Library is your repository for additional In short, Connect Accounting offers you and your
resources to improve student engagement in and students powerful tools and features that optimize

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Technology xiii

your time and energies, enabling you to focus on In addition to Blackboard

course content, teaching, and student learning. integration, course car-
Connect Accounting also offers a wealth of content tridges for whichever online
resources for both instructors and students. This course management system you
state-of-the-art, thoroughly tested system sup- use (e.g., WebCT or eCollege)
ports you in preparing students for the world that are available for Messier 8e. Our
awaits. cartridges are specifically designed to make it easy
to navigate and access content online. They are
For more information about Connect, go to www.
easier than ever to install on the latest version of
mcgrawhillconnect.com, or contact your local
the course management system available today.
McGraw-Hill sales representative.
Tegrity Campus,
a new McGraw-
Online Course Management Hill company,
provides a service
McGraw-Hill Higher Education and Blackboard that makes class time available 24/7 by automati-
have teamed up. What does this mean for you? cally capturing every lecture in a searchable for-
mat for students to review when they study and
1. Your life, simplified. Now complete assignments. With a simple one-click
you and your students can ac- start-and-stop process, you capture all computer
cess McGraw-Hill’s Connect™ screens and corresponding audio. Students can
and Create™ right from within replay any part of any class with easy-to-use
your Blackboard course—all browser-based viewing on a PC, Mac, iPod or
with one single sign-on. Say iPad, or any other mobile device.
goodbye to the days of logging in to multiple
applications. Educators know that the more students can see,
2. Deep integration of content and tools. Not hear, and experience class resources, the better
only do you get single sign-on with Connect they learn. In fact, studies prove it. With Tegrity
and Create™, you also get deep integration Campus, students quickly recall key moments by
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assignments, all the tools you need are right semester of class recordings. Help turn all your
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 Confirming Pages

8th edition instructor

and student supplements
For Instructors. . .
Instructor’s Resource CD-ROM (ISBN 9780077425937, MHID 0077425936): Contains all
essential course supplements:
• Solutions Manual, revised by William F. Messier, Jr., Steven M. Glover, and
Douglas F. Prawitt
• Instructor’s Manual, revised by Cassy Budd, Brigham Young University, and
the text authors
• Test Bank with AACSB, AICPA, and Bloom’s Taxonomy tags, revised by Cassy Budd and
the text authors
• Instructor PowerPoint Presentations, revised by Cassy Budd and the text authors
• EarthWear Minicase Solutions
• Solutions to ACL assignments

Online Learning Center (OLC): mhhe.com/messier8e

The Instructor Edition of the Auditing & Assurance Services, 8e OLC is password-protected
and another convenient place for instructors to access essential course supplements. The OLC
contains the same instructor materials available on the Instructor’s Resource CD. Additional
resources include: Access to EZ Test Online (McGraw-Hill’s flexible electronic testing pro-
gram), Links to Professional Resources, Sample Syllabi, Text Updates, and Digital Image
Library.

For Students. . .
Online Learning Center (OLC): mhhe.com/messier8e
The Student Edition contains tools designed to enhance students’ learning experience:
• EarthWear Mini-Cases, by Messier, Glover, and Prawitt
• ACL Assignments, by Messier, Glover, and Prawitt
• Roger Company ACL files for use with assignments
• Kaplan CPA Review Simulations
• Online multiple choice chapter quizzes, by Cassy Budd, Brigham Young University, and
revised by the text authors
• Student PowerPoint Presentations, by Cassy Budd and revised by the text authors
• Relevant Accounting and Auditing Pronouncements by chapter
• Link to EarthWear Clothiers home page
• Link to Willis & Adams, CPAs home page
• Professional Judgment module

Assurance of Learning Ready

Many educational institutions today are focused on the notion of assurance of learning, an important
element of some accreditation standards. Messier’s Auditing and Assurance Services: A Systematic
Approach is designed specifically to support your assurance of learning initiatives with a simple, yet
powerful, solution.

xiv

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8th Edition Instructor and Student Supplements xv

Each chapter in the book begins with a list of numbered learning objectives, which appear throughout
the chapter as well as in the end-of-chapter assignments. Each test bank question for Auditing and
Assurance Services: A Systematic Approach maps to a specific chapter learning outcome/objective listed
in the text. Each test bank question also identifies topic area, level of difficulty, Bloom’s Taxonomy level,
AACSB and AICPA skill areas. You can use our test bank platform, EZ Test Online, or Connect Accounting
to easily query for learning outcomes/objectives that directly relate to the learning objectives for your
course. You can then use the reporting features of EZ Test to aggregate student results in similar fashion,
making the collection and presentation of assurance of learning data simple and easy.

AACSB Statement
The McGraw-Hill Companies is a proud corporate member of AACSB International. Understanding
the importance and value of AACSB accreditation, Auditing and Assurance Services 8e recognizes the
curricula guidelines detailed in the AACSB standards for business accreditation by connecting selected
questions in the text and test bank to the six general knowledge and skill guidelines in the AACSB
standards.

The statements contained in Auditing and Assurance Services 8e 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, the mission of the school, and the faculty. While Auditing and Assurance Services
8e and the teaching package make no claim of any specific AACSB qualification or evaluation, we
have within Auditing and Assurance Services 8e labeled selected questions according to the six general
knowledge and skills areas.

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Acknowledgments
First and foremost, we thank our families for their continuous support. We would like
to acknowledge the American Institute of Certified Public Accountants for permission
to quote from auditing standards, the Code of Professional Conduct, the Uniform CPA
Examination, and the Journal of Accountancy. We would like to thank ACL Services, Ltd.,
for granting permission to distribute the educational version of ACL software with our
textbook. We would also like to thank Kaplan for the use of their CPA simulations. We
are grateful to Helen Roybark of Radford University for her careful accuracy check of
the text manuscript, solutions manual, and supplements; and Cassy Budd of Brigham
Young University for her help with updating the Test Bank, Instructor’s Manual, Quizzes,
and PowerPoints. Finally, we would like to extend our gratitude to Jace Garrett, Brant
Christensen, Jonathan Liljegren, and Daniel Strange for their research assistance.

We received extensive feedback from users and nonusers of the 3rd through 7th editions of
the text via surveys and in-depth reviews. These comments helped us develop and enhance
the 8th edition; thank you to the following colleagues for their invaluable advice:

Kevin Den Adel, Laura DeLaune,

University of Iowa Louisiana State University
Pervaiz Alam, Todd DeZoort,
Kent State University The University of Alabama
Jeffrey Archambault, William Dilla,
Marshall University Iowa State University
Deborah Archambeault, Timothy Dimond,
University of Tennessee Chatanooga Northern Illinois University
Jeff Austin, Mary Doucet,
Southern Methodist University California State University Bakersfield
David S. Baglia, Rafik Elias,
Grove City College California State University, Los Angeles
Katherine Barker, Robert Eskew,
University of South Florida St. Petersburg Purdue University
Thomas Batina, William Felix,
University of Minnesota University of Arizona
Duane M. Brandon, Donna Free,
Auburn University Oakland University
Kevin F. Brown, James Fuehrmeyer, Jr.,
Wright State University University of Notre Dame
Linda Chase, Ross D. Fuerman,
Baldwin Wallace College Suffolk University
Shifei Chung, David Gelb,
Rowan University Seton Hall University
Bob Cluskey, Tony Greig,
University of West Georgia Purdue University
Jeffrey Cohen, James D. Hansen,
Boston College Minnesota State University Moorhead
James Crockett, Julia Higgs,
University of Southern Mississippi Florida Atlantic University
Mary Curtis, Vicky Hoffman,
University of North Texas University of Pittsburgh
Frank Darcoa, Charles Holley,
Loyola Marymount University Virginia Commonwealth University

xvi

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Acknowledgments xvii

Carl Hollingsworth, John Rigsby,

Clemson University Mississippi State University
Venkat Iyer, Sandra Robertson,
University of North Carolina, Greensboro Furman University
Mary Keim, Pamela Roush,
California State University, San Marcos University of Central Florida
William Kerler III, Helen M. Roybark,
University of North Carolina Wilmington Radford University
Linda Larson, Lydia Schleifer,
Central Washington University – Lynwood Clemson University
Center Brian Shapiro,
Pam Legner, University of Minnesota, Minneapolis
College of DuPage (IL) Charles Stanley,
Ralph Licastro, Baylor University
Pennsylvania State University, Jay Thibodeau,
University Park Bentley College
Nicholas Maruda, Bill Thomas,
Auburn Montgomery Baylor University
Diane Matson, Don Tidrick,
University of St. Thomas Northern Illinois University
Robert McCabe, Rick Turpen,
California State University, Fullerton University of Alabama at Birmingham
Mark McLaren, Scott Vandervelde,
Washington University University of Southern Carolina
Robert Minnear, Thomas Vermeer,
Emory University University of Delaware
Natalia Mintchik, Paul Walker,
University of Missouri, St. Louis University of Virginia
Jennifer Mueller, Tom Weirich,
Auburn University Central Michigan University
Albert Nagy, Thomas Wetzel,
John Carroll University Oklahoma State University
Hossein Nouri, Glen Van Whye,
The College of New Jersey Pacific Lutheran University
Vincent Owhoso, Jeff Wong,
Northern Kentucky University University of Nevada, Reno
Susan Parker, George Young,
Santa Clara University Florida Atlantic University
Abe Qastin,
Lakeland College

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Brief Contents

PART 1 Chapter 7
Introduction to Assurance Auditing Internal Control over Financial
and Financial Statement Reporting 225
Auditing 1
PART 4
Chapter 1 Statistical and Nonstatistical
An Introduction to Assurance and Sampling Tools for Auditing 269
Financial Statement Auditing 3
Chapter 8
Chapter 2 Audit Sampling: An Overview and
The Financial Statement Auditing Application to Tests of Controls 271
Environment 35
Chapter 9
PART 2 Audit Sampling: An Application
Audit Planning and Basic to Substantive Tests of Account
Auditing Concepts 67 Balances 311

Chapter 3 PART 5
Audit Planning, Types of Audit Tests, Auditing Business
and Materiality 69 Processes 349

Chapter 4 Chapter 10
Risk Assessment 99 Auditing the Revenue Process 351

Chapter 5 Chapter 11
Evidence and Documentation 131 Auditing the Purchasing Process 401

PART 3 Chapter 12
Understanding and Auditing Auditing the Human Resource
Internal Control 183 Management Process 439

Chapter 6 Chapter 13
Internal Control in a Financial Auditing the Inventory Management
Statement Audit 185 Process 467

xviii

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Brief Contents xix

Chapter 14 PART 7
Auditing the Financing/Investing Process: Professional
Prepaid Expenses, Intangible Assets, and Responsibilities 643
Property, Plant, and Equipment 497
Chapter 19
Chapter 15 Professional Conduct, Independence,
Auditing the Financing/Investing and Quality Control 645
Process: Long-Term Liabilities,
Stockholders’ Equity, and Income Chapter 20
Statement Accounts 523
Legal Liability 691

Chapter 16 PART 8
Auditing the Financing/Investing Assurance, Attestation, and
Process: Cash and Investments 545
Internal Auditing Services 727
PART 6 Chapter 21
Completing the Audit and Assurance, Attestation, and Internal
Reporting Responsibilities 577 Auditing Services 729

Chapter 17 Professional Judgment Module

Completing the Audit Engagement 579 (available online on the text website
www.mhhe.com/messier8e)
Chapter 18 Index 769
Reports on Audited Financial
Statements 613

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Table of Contents

PART 1 The Unqualified/Unmodified Audit

Introduction to Assurance and Report 22
Other Types of Audit Reports 24
Financial Statement Auditing 1
Conclusion 25
Key Terms 26
Chapter 1
Review Questions 27
An Introduction to Assurance Multiple-Choice Questions 27
and Financial Statement Auditing 3 Problems 29
The Study of Auditing 4 Discussion Case 31
The Demand for Auditing and Assurance 5 Internet Assignment 32
Principals and Agents 5 Hands-On Cases 32
The Role of Auditing 7
An Assurance Analogy: The Case of the Chapter 2
House Inspector 8 The Financial Statement Auditing
Seller Assertions, Information Asymmetry, Environment 35
and Inspector Characteristics 8 Types of Auditors 36
Desired Characteristics of the House External Auditors 36
Inspection Service 9 Internal Auditors 36
Relating the House Inspection Analogy Government Auditors 37
to Financial Statement Auditing 10 Forensic Auditors 38
Management Assertions and Financial Types of Other Audit, Attest,
Statements 10 and Assurance Services 38
Auditing, Attest, and Assurance Services Other Audit Services 39
Defined 12 Attest Services 40
Auditing 12 Assurance Services 40
Attestation 13 Other Nonaudit Services 40
Assurance 13 Public Accounting Firms 41
Fundamental Concepts in Conducting a Organization and Composition 41
Financial Statement Audit 14 A Decade of Challenge and Change for
Materiality 15 Financial Statement Auditors 42
Audit Risk 15 Government Regulation 43
Evidence Regarding Management Society’s Expectations and the Auditor’s
Assertions 16 Responsibilities 44
Sampling: Inferences Based on Limited The Context of Financial Statement
Observations 16 Auditing 44
The Audit Process 17 Business as the Primary Context of
Overview of the Financial Statement Auditing 44
Auditing Process 17 A Model of Business 45
Major Phases of the Audit 19 Corporate Governance 45
xx

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Contents xxi

Objectives, Strategies, Processes, Controls, Client Continuance 71

Transactions, and Reports 46 Preliminary Engagement Activities 71
A Model of Business Processes: Five Determine the Audit Engagement Team
Components 46 Requirements 71
Organizations That Affect the Public Assess Compliance with Ethical and
Accounting Profession 48 Independence Requirements 72
Securities and Exchange Commission Establish an Understanding with the
(SEC) 50 Client 72
Public Company Accounting Oversight Planning the Audit 76
Board (PCAOB) 50 Audit Plan and Strategy 76
American Institute of Certified Public Assess Business Risks 77
Accountants (AICPA) 50 Establish Materiality 77
Financial Accounting Standards Board Consider Multilocations or Business
(FASB) 51 Units 77
International Auditing and Assurance Assess the Need for Specialists 78
Standards Board (IAASB) 51 Assess the Possibility of Illegal Acts 78
International Accounting Standards Identify Related Parties 79
Board (IASB) 51 Consider Additional Value-Added
Auditing Standards 52 Services 80
Three Sets of Auditing Standards: The Roles Document the Overall Audit Strategy, Audit
of the ASB, PCAOB, and IAASB 52 Plan, and Prepare Audit Programs 80
The 10 Generally Accepted Auditing Supervision of the Audit 81
Standards 53 Types of Audit Tests 82
Principles Underlying an Audit Conducted Risk Assessment Procedures 82
in Accordance with Generally Accepted Tests of Controls 82
Auditing Standards 55 Substantive Procedures 83
Auditing Standards and the Dual-Purpose Tests 84
AU Codification 56 Materiality 84
Ethics, Independence, and the Code Steps in Applying Materiality 85
of Professional Conduct 57 An Example 89
Conclusion 58 Key Terms 91
Key Terms 58 Review Questions 91
Review Questions 59 Multiple-Choice Questions 92
Multiple-Choice Questions 60 Problems 94
Problems 62 Discussion Cases 96
Discussion Cases 64 Internet Assignments 97
Internet Assignments 66 Hands-On Cases 97
Hands-On Cases 66
Chapter 4
PART 2 Risk Assessment 99
Audit Planning and Basic Audit Risk 100
Auditing Concepts 67 The Audit Risk Model 100
Use of the Audit Risk Model 102
Chapter 3 The Auditor’s Risk Assessment Process 104
Audit Planning, Types of Audit Tests, Management’s Strategies, Objectives,
and Materiality 69 and Business Risks 104
Client Acceptance and Continuance 70 Business Risk and the Risk of Material
Prospective Client Acceptance 70 Misstatement 105

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xxii Contents

Auditor’s Risk Assessment Procedures 105 Inspection of Tangible Assets 142

The Importance of the Auditor Observation 143
Understanding the Entity and Its Inquiry 143
Environment 107 External Confirmation 144
Evaluate the Entity’s Risk Assessment Recalculation 145
Process 110 Reperformance 145
Assessing the Risk of Material Analytical Procedures 145
Misstatement Due to Error or Fraud 111 Scanning 145
Types and Causes of Misstatements 111 Reliability of the Types of Evidence 146
The Fraud Risk Assessment Process 112 The Audit Testing Hierarchy 146
Conditions Indicative of Fraud and An “Assurance Bucket” Analogy 148
Fraud Risk Factors 114 Audit Documentation 150
The Auditor’s Response to the Results of Objectives of Audit Documentation 150
the Risk Assessments 117 Content of Audit Documentation 150
Evaluation of Audit Test Results 119 Examples of Audit Documentation 152
Documentation of the Auditor’s Risk Format of Audit Documentation 154
Assessment and Response 120 Organization of Audit Documentation 155
Communications about Fraud to Ownership of Audit Documentation 155
Management, the Audit Committee, Audit Document Archiving and
and Others 120 Retention 156
Key Terms 122 Advanced Module 1: Analytical
Review Questions 123 Procedures 158
Multiple-Choice Questions 123 Substantive Analytical Procedures 158
Problems 125 Final Analytical Procedures 169
Discussion Case 127 Advanced Module 2: Selected
Internet Assignment 128 Financial Ratios Useful as Analytical
Hands-On Cases 129 Procedures 169
Short-Term Liquidity Ratios 170
Activity Ratios 170
Chapter 5
Profitability Ratios 171
Evidence and Documentation 131 Coverage Ratios 172
The Relationship of Audit Evidence to the Key Terms 173
Audit Report 132 Review Questions 174
Management Assertions 133 Multiple-Choice Questions 174
Assertions about Classes of Transactions Problems 176
and Events during the Period 134 Discussion Cases 179
Assertions about Account Balances at the Internet Assignment 182
Period End 135 Hands-On Cases 182
Assertions about Presentation and
Disclosure 136
PART 3
The Concepts of Audit Evidence 137
The Nature of Audit Evidence 137
Understanding and Auditing
The Sufficiency and Appropriateness of Internal Control 183
Audit Evidence 138
Chapter 6
The Evaluation of Audit Evidence 140
Audit Procedures for Obtaining Audit Internal Control in a Financial
Evidence 140 Statement Audit 185
Inspection of Records or Documents 141 Introduction 186

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Contents xxiii

Internal Control—An Overview 186 Interim Substantive Procedures 209

Definition of Internal Control 186 Auditing Accounting Applications
Controls Relevant to the Audit 186 Processed by Service
The Effect of Information Technology on Organizations 209
Internal Control 187 Communication of Internal
The COSO Framework 187 Control–Related Matters 211
Components of Internal Control 187 Advanced Module 1: Types of Controls
Control Environment 188 in an IT Environment 212
The Entity’s Risk Assessment General Controls 212
Process 191 Application Controls 213
Information System and Advanced Module 2: Flowcharting
Communication 192 Techniques 216
Control Activities 192 Symbols 217
Monitoring of Controls 193 Organization and Flow 217
Planning an Audit Strategy 195 Key Terms 217
Substantive Strategy 197 Review Questions 218
Reliance Strategy 197 Multiple-Choice Questions 218
Problems 220
Obtain an Understanding of Internal
Discussion Case 222
Control 198
Hands-On Cases 223
Overview 198
Understanding the Control
Environment 199 Chapter 7
Understanding the Entity’s Risk Auditing Internal Control over Financial
Assessment Process 199 Reporting 225
Understanding the Information System Management Responsibilities under
and Communications 201 Section 404 226
Understanding Control Activities 201 Auditor Responsibilities under Section 404
Understanding Monitoring of and AS5 226
Controls 201 Internal Control over Financial Reporting
Documenting the Understanding of Defined 227
Internal Control 202 Internal Control Deficiencies Defined 227
The Effect of Entity Size on Internal Control Deficiency 227
Control 202 Material Weakness 227
The Limitations of an Entity’s Internal Significant Deficiency 228
Control 203 Likelihood and Magnitude 228
Assessing Control Risk 204 Management’s Assessment Process 228
Identifying Specific Controls That Will Be Framework Used by Management to
Relied Upon 205 Conduct Its Assessment 229
Performing Tests of Controls 205 Identify Financial Reporting Risks and
Concluding on the Achieved Level of Related Controls 230
Control Risk 206 Consider Which Locations to Include in
Documenting the Achieved Level of the Evaluation 230
Control Risk 206 Evaluate Evidence About the Operating
An Example 206 Effectiveness of ICFR 231
Substantive Procedures 207 Reporting Considerations 231
Timing of Audit Procedures 208 Management’s Documentation 232
Interim Tests of Controls 208 Performing an Audit of ICFR 233

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xxiv Contents

Planning the Audit of ICFR 234 Use of Service Organizations 253

The Role of Risk Assessment and the Risk Safeguarding of Assets 253
of Fraud 234 Advanced Module 2: Computer-Assisted
Scaling the Audit 235 Audit Techniques 254
Using the Work of Others 235 Generalized Audit Software 254
Using a Top-Down, Risk-Based Custom Audit Software 255
Approach 236 Test Data 255
Identify Entity-Level Controls 236 Key Terms 256
Identifying Significant Accounts and Review Questions 257
Disclosures and Their Relevant Multiple-Choice Questions 258
Assertions 237 Problems 261
Understanding Likely Sources of Internet Assignments 267
Misstatements 238 Hands-On Cases 267
Select Controls to Test 238
Test the Design and Operating PART 4
Effectiveness of Controls 239
Statistical and Nonstatistical
Evaluating Design Effectiveness of
Controls 239
Sampling Tools for Auditing 269
Testing and Evaluating Operating
Effectiveness of Controls 239 Chapter 8
Evaluating Identified Control Audit Sampling: An Overview and
Deficiencies 241 Application to Tests of Controls 271
An Example 243 Introduction 272
Remediation of a Material Weakness 245 Definitions and Key Concepts 273
Written Representations 245 Audit Sampling 273
Auditor Documentation Sampling Risk 273
Requirements 246 Confidence Level 275
Auditor Reporting on ICFR 246 Tolerable and Expected Error 275
Elements of the Auditor’s Report 247 Audit Evidence Choices That Do and Do
Unqualified Report 247 Not Involve Sampling 276
Adverse Report for a Material Types of Audit Sampling 277
Weakness 247 Nonstatistical versus Statistical
Disclaimer for Scope Limitation 250 Sampling 277
Other Reporting Issues 251 Types of Statistical Sampling
Management’s Report Incomplete or Techniques 278
Improperly Presented 251 Attribute Sampling Applied to Tests of
The Auditor Decides to Refer to the Controls 279
Report of Other Auditors 251 Planning 280
Subsequent Events 251 Performance 288
Management’s Report Contains Evaluation 293
Additional Information 251 Nonstatistical Sampling for Tests of
Reporting on a Remediated Material Controls 297
Weakness at an Interim Date 252 Determining the Sample Size 297
Additional Required Communications in Selecting the Sample Items 298
an Audit of ICFR 252 Calculating the Computed Upper
Advanced Module 1: Special Considerations Deviation Rate 298
for an Audit of Internal Control 253 Conclusion 299

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Contents xxv

Advanced Module 1: Considering the Key Terms 341

Effect on a Sample Size of a Small Review Questions 342
Population 299 Multiple-Choice Questions 342
Advanced Module 2: Comparing Problems 344
Terminology for Attribute Sampling Discussion Cases 347
between ACL and Sampling Tables 300 Hands-On Cases 348
Key Terms 300
Review Questions 301 PART 5
Multiple-Choice Questions 302 Auditing Business
Problems 304
Processes 349
Discussion Case 308
Hands-On Cases 308
Chapter 10
Chapter 9 Auditing the Revenue Process 351
Audit Sampling: An Application Revenue Recognition 353
to Substantive Tests of Account Overview of the Revenue Process 354
Balances 311 Types of Transactions and Financial
Sampling for Substantive Tests of Details Statement Accounts Affected 355
of Account Balances 312 Types of Documents and Records 357
Monetary-Unit Sampling 313 The Major Functions 361
Advantages 314 Key Segregation of Duties 363
Disadvantages 314 Inherent Risk Assessment 364
Applying Monetary-Unit Sampling 314 Industry-Related Factors 364
Planning 315 The Complexity and Contentiousness of
Performance 319 Revenue Recognition Issues 364
Evaluation 321 The Difficulty of Auditing Transactions
Nonstatistical Sampling for Tests of and Account Balances 365
Account Balances 328 Misstatements Detected in Prior
Identifying Individually Significant Audits 365
Items 328 Control Risk Assessment 365
Determining the Sample Size 330 Understand and Document Internal
Selecting Sample Items 330 Control 365
Calculating the Sample Results 331 Plan and Perform Tests of Controls 366
An Example of Nonstatistical Set and Document Control Risk 367
Sampling 332 Control Activities and Tests of Controls—
The Rise and Fall of Statistical Audit Revenue Transactions 367
Sampling 333 Occurrence of Revenue Transactions 369
Advanced Module 1: Classical Variables Completeness of Revenue
Sampling 334 Transactions 370
Advantages 336 Authorization of Revenue
Disadvantages 336 Transactions 370
Applying Classical Variables Accuracy of Revenue Transactions 370
Sampling 336 Cutoff of Revenue Transactions 371
Advanced Module 2: Comparing Classification of Revenue
Terminology for Monetary-Unit Transactions 371
Sampling between ACL and Manual Control Activities and Tests of Controls—
Calculation 340 Cash Receipts Transactions 371

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xxvi Contents

Occurrence of Cash Receipts Overview of the Purchasing Process 402

Transactions 371 Types of Transactions and Financial
Completeness of Cash Receipts Statement Accounts Affected 403
Transactions 373 Types of Documents and Records 404
Authorization of Cash Discounts 373 The Major Functions 407
Accuracy of Cash Receipts The Key Segregation of Duties 409
Transactions 374 Inherent Risk Assessment 410
Cutoff of Cash Receipts Transactions 374 Industry-Related Factors 410
Classification of Cash Receipts 374 Misstatements Detected in Prior
Control Activities and Tests of Audits 410
Controls—Sales Returns and Allowances Control Risk Assessment 411
Transactions 374 Understand and Document Internal
Relating the Assessed Level of Control Risk Control 411
to Substantive Procedures 375 Plan and Perform Tests of Controls 412
Auditing Revenue-Related Accounts 375 Set and Document Control Risk 412
Substantive Analytical Procedures 376 Control Activities and Tests of Controls—
Tests of Details of Classes of Transactions, Purchase Transactions 413
Account Balances, and Disclosures 378 Occurrence of Purchase Transactions 413
Completeness 379 Completeness of Purchase
Cutoff 380 Transactions 415
Existence 381 Authorization of Purchase
Rights and Obligations 381 Transactions 415
Valuation and Allocation 381 Accuracy of Purchase Transactions 415
Classification 382 Cutoff of Purchase Transactions 416
Other Presentation and Disclosure Classification of Purchase
Assertions 383 Transactions 416
The Confirmation Process—Accounts Control Activities and Tests of Controls—
Receivable 384 Cash Disbursement Transactions 416
Types of Confirmations 385 Occurrence of Cash Disbursement
Timing 386 Transactions 416
Confirmation Procedures 387 Completeness of Cash Disbursement
Alternative Procedures 388 Transactions 418
Auditing Other Receivables 389 Authorization of Cash Disbursement
Evaluating the Audit Findings—Revenue- Transactions 418
Related Accounts 389 Accuracy of Cash Disbursement
Key Terms 390 Transactions 418
Review Questions 391 Cutoff of Cash Disbursement
Multiple-Choice Questions 391 Transactions 418
Problems 393 Classification of Cash Disbursement
Discussion Cases 397 Transactions 419
Internet Assignments 398 Control Activities and Tests of Controls—
Hands-On Cases 399 Purchase Return Transactions 419
Relating the Assessed Level of Control Risk
to Substantive Procedures 419
Chapter 11
Auditing Accounts Payable and Accrued
Auditing the Purchasing Process 401 Expenses 420
Expense and Liability Recognition 402 Substantive Analytical Procedures 421

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Contents xxvii

Tests of Details of Classes of Transactions, Accuracy of Payroll Transactions 450

Account Balances, and Disclosures 421 Classification of Payroll
Completeness 422 Transactions 450
Existence 424 Relating the Assessed Level of Control Risk
Cutoff 424 to Substantive Procedures 450
Rights and Obligations 425 Auditing Payroll-Related Accounts 450
Valuation 425 Substantive Analytical Procedures 451
Classification and Tests of Details of Classes of Transactions,
Understandability 425 Account Balances, and Disclosures 452
Other Presentation Disclosure Payroll Expense Accounts 453
Assertions 425 Accrued Payroll Liabilities 453
Accounts Payable Confirmations 426 Evaluating the Audit Findings—Payroll-
Evaluating the Audit Findings—Accounts Related Accounts 456
Payable and Related 427 Advanced Module: Share-Based
Advanced Module: Auditing the Tax Compensation 456
Provision and Related Balance Sheet Key Terms 458
Accounts 428 Review Questions 458
Key Terms 430 Multiple-Choice Questions 459
Review Questions 431 Problems 460
Multiple-Choice Questions 431 Discussion Cases 463
Problems 433 Internet Assignment 465
Discussion Case 436 Hands-On Cases 465
Internet Assignments 437
Hands-On Cases 437
Chapter 13
Auditing the Inventory Management
Chapter 12 Process 467
Auditing the Human Resource Overview of the Inventory Management
Management Process 439 Process 468
Overview of the Human Resource Types of Documents and Records 469
Management Process 440 The Major Functions 471
Types of Transactions and Financial The Key Segregation of Duties 472
Statement Accounts Affected 441 Inherent Risk Assessment 473
Types of Documents and Records 441 Industry-Related Factors 473
The Major Functions 442 Engagement and Operating
The Key Segregation of Duties 444 Characteristics 473
Inherent Risk Assessment 445 Control Risk Assessment 475
Control Risk Assessment 446 Understand and Document Internal
Understand and Document Internal Control 475
Control 447 Plan and Perform Tests of Controls 475
Plan and Perform Tests of Controls 447 Set and Document the Control Risk 476
Set and Document the Control Risk 448 Control Activities and Tests of Controls—
Control Activities and Tests of Controls— Inventory Transactions 476
Payroll Transactions 448 Occurrence of Inventory
Occurrence of Payroll Transactions 448 Transactions 476
Authorization of Payroll Completeness of Inventory
Transactions 448 Transactions 476

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xxviii Contents

Authorization of Inventory Substantive Procedures—Prepaid

Transactions 478 Insurance 499
Accuracy of Inventory Transactions 478 Substantive Analytical Procedures for
Cutoff of Inventory Transactions 478 Prepaid Insurance 499
Classification of Inventory Tests of Details of the Prepaid
Transactions 479 Insurance 499
Relating the Assessed Level of Control Risk Existence and Completeness 499
to Substantive Procedures 479 Rights and Obligations 500
Auditing Inventory 479 Valuation 500
Substantive Analytical Procedures 480 Classification 500
Auditing Standard Costs 481 Auditing Intangible Assets 501
Materials 481 Inherent Risk Assessment—Intangible
Labor 482 Assets 501
Overhead 482 Control Risk Assessment—Intangible
Observing Physical Inventory 482 Assets 502
Tests of Details of Classes of Transactions, Substantive Procedures—Intangible
Account Balances, and Disclosures 483 Assets 502
Accuracy 485 Substantive Analytical Procedures for
Cutoff 485 Intangible Assets 502
Existence 485 Tests of Details of Intangible Assets 502
Completeness 485 Auditing the Property Management
Rights and Obligations 486 Process 504
Valuation and Allocation 486 Types of Transactions 504
Classification and Understandability 486 Overview of the Property Management
Other Presentation and Disclosure Process 505
Assertions 487 Inherent Risk Assessment—Property
Evaluating the Audit Findings— Management Process 506
Inventory 487 Complex Accounting Issues 506
Key Terms 488 Easy and Difficult Transactions to
Review Questions 488 Audit 506
Multiple-Choice Questions 489 Misstatements Detected in Prior
Problems 491 Audits 506
Discussion Case 495 Control Risk Assessment—Property
Internet Assignments 495 Management Process 507
Hands-On Cases 495 Occurrence and Authorization 507
Completeness 508
Chapter 14 Segregation of Duties 508
Auditing the Financing/Investing Substantive Procedures—Property, Plant,
Process: Prepaid Expenses, Intangible and Equipment 509
Assets, and Property, Plant, and Substantive Analytical Procedures—
Equipment 497 Property, Plant, and Equipment 509
Auditing Prepaid Expenses 498 Tests of Details of Transactions, Account
Inherent Risk Assessment—Prepaid Balances, and Disclosures—Property,
Expenses 498 Plant, and Equipment 510
Control Risk Assessment—Prepaid Evaluating the Audit Findings—Property,
Expenses 498 Plant, and Equipment 513

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Key Terms 514 Review Questions 537

Review Questions 514 Multiple-Choice Questions 537
Multiple-Choice Questions 515 Problems 539
Problems 517 Discussion Case 542
Discussion Case 519 Internet Assignment 542
Internet Assignments 520 Hands-On Cases 543
Hands-On Cases 520
Chapter 16
Chapter 15 Auditing the Financing/Investing
Auditing the Financing/Investing Process: Cash and Investments 545
Process: Long-Term Liabilities, Auditing Cash 546
Stockholders’ Equity, and Income Types of Bank Accounts 547
Statement Accounts 523 General Cash Account 547
Auditing Long-Term Debt 524 Imprest Cash Accounts 547
Inherent Risk Assessment—Long-Term Branch Accounts 547
Debt 525 Control Risk Assessment—Cash 548
Control Risk Assessment—Long-Term Substantive Procedures—Cash 548
Debt 525 Substantive Analytical Procedures—
Assertions and Related Control Cash 548
Activities 525 Substantive Tests of Details of
Substantive Procedures—Long-Term Transactions and Balances—Cash 549
Debt 527 Auditing the General Cash Account 550
Auditing Stockholders’ Equity 529 Fraud-Related Audit Procedures 554
Control Risk Assessment—Stockholders’ Auditing a Payroll or Branch Imprest
Equity 530 Account 557
Assertions and Related Control Auditing a Petty Cash Fund 557
Activities 530 Disclosure Issues for Cash 559
Segregation of Duties 531 Auditing Investments 559
Auditing Capital-Stock Accounts 531 Control Risk Assessment—Investments 560
Occurrence and Completeness 531 Assertions and Related Control
Valuation 532 Activities 560
Completeness of Disclosures 532 Segregation of Duties 561
Auditing Dividends 532 Substantive Procedures—Investments 562
Auditing Retained Earnings 533 Substantive Analytical Procedures—
Auditing Income Statement Accounts 533 Investments 562
Assessing Control Risk for Business Tests of Details—Investments 562
Processes—Income Statement Advanced Module: Auditing Fair Value
Accounts 534 Measurements 564
Substantive Procedures—Income Understanding How Management Makes
Statement Accounts 534 Fair Value Measurements 566
Direct Tests of Balance Sheet Considering Whether Specialized Skills or
Accounts 534 Knowledge Is Required 567
Substantive Analytical Procedures for Testing the Entity’s Fair Value
Income Statement Accounts 535 Measurements 567
Tests of Selected Account Balances 536 Evaluating the Reasonableness of the
Key Terms 536 Fair Value Measurements 568

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Key Terms 568 Review Questions 600

Review Questions 569 Multiple-Choice Questions 600
Multiple-Choice Questions 569 Problems 602
Problems 571 Discussion Cases 607
Internet Assignments 576 Internet Assignments 610
Hands-On Cases 576 Hands-On Cases 610

PART 6 Chapter 18
Completing the Audit and Reports on Audited Financial
Reporting Responsibilities 577 Statements 613
Reporting on the Financial Statement
Chapter 17 Audit: The Standard Unqualified/
Completing the Audit Engagement 579 Unmodified Audit Report 614
Review for Contingent Liabilities 580 The Standard Unqualified Audit Report
Audit Procedures for Identifying for Public Companies 614
Contingent Liabilities 581 The Standard Unmodified Audit Report
Legal Letters 581 for All Entities Other Than Public
Commitments 584 Companies 615
Review of Subsequent Events for Audit of Explanatory Language Added to the
Financial Statements 584 Standard Unqualified/Unmodified
Dual Dating 586 Financial Statement Audit Report 616
Audit Procedures for Subsequent Modified Wording for Opinion Based
Events 586 in Part on the Report of Another
Review of Subsequent Events for the Auditor 617
Audit of Internal Control over Financial Circumstances Requiring Explanatory
Reporting 587 Language in an Additional
Final Evidential Evaluation 588 Paragraph 618
Final Analytical Procedures 588 Departures from an Unqualified/
Representation Letter 589 Unmodified Financial Statement Audit
Working Paper Review 589 Report 621
Final Evaluation of Audit Results 592 Conditions for Departure 621
Evaluating Financial Statement Types of Financial Statement Audit
Presentation and Disclosure 593 Reports Other than Unqualified/
Independent Engagement Quality Unmodified 622
Review 594 The Effect of Materiality on Financial
Archiving and Retention 594 Statement Reporting 622
Going Concern Considerations 594 Discussion of Conditions Requiring Other
Communications with Those Charged with Types of Financial Statement Audit
Governance and Management 596 Reports 624
Communications Regarding the Audit Scope Limitation 624
of Internal Control over Financial Statements Not in Conformity with
Reporting 597 GAAP 625
Management Letter 598 Auditor Not Independent 627
Subsequent Discovery of Facts Existing at Special Reporting Issues 627
the Date of the Auditor’s Report 598 Reports on Comparative Financial
Key Terms 599 Statements 628

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Different Reports on Comparative Independence 656

Financial Statements 628 Integrity and Objectivity 669
A Change in Report on the Prior-Period General Standards and Accounting
Financial Statements 629 Principles 670
Report by a Predecessor Auditor 629 General Standards and Compliance with
Other Information in Documents Containing Standards 670
Audited Financial Statements 630 Accounting Principles 671
Special Reports Relating to Financial Responsibilities to Clients 671
Statements 630 Confidential Client Information 671
Financial Statements Prepared According Contingent Fees 672
to a Special Purpose Framework 631 Other Responsibilities and Practices 672
Specified Elements, Accounts, or Items of Acts Discreditable 672
a Financial Statement 631 Advertising and Other Forms of
Compliance Reports Related to Audited Solicitation 673
Financial Statements 632 Commissions and Referral Fees 673
Key Terms 633 Form of Organization and Name 674
Review Questions 634 Disciplinary Actions 674
Multiple-Choice Questions 634 Don’t Lose Sight of the Forest for the
Problems 637 Trees 675
Discussion Case 641 Quality Control Standards 675
Hands-On Cases 642 System of Quality Control 676
Elements of Quality Control 677
PART 7 PCAOB Inspections of Registered Public
Professional Accounting Firms 679
Responsibilities 643 Key Terms 679
Review Questions 681
Chapter 19 Multiple-Choice Questions 681
Problems 684
Professional Conduct, Independence,
Discussion Cases 686
and Quality Control 645
Internet Assignments 688
Ethics and Professional Conduct 646 Hands-On Cases 689
Ethics and Professional Conduct
Defined 646
Chapter 20
Theories of Ethical Behavior 647
Example—An Ethical Challenge 648 Legal Liability 691
An Overview of Ethics and Professionalism Introduction 692
in Public Accounting 650 Historical Perspective 692
A Tale of Two Companies 650 Overview of Auditor Legal Liability 693
Standards for Auditor Common Law—Clients 695
Professionalism 651 Breach of Contract—Client Claims 695
The AICPA Code of Professional Conduct: Negligence—Client Claims 695
A Comprehensive Framework for Fraud—Client Claims 698
Auditors 653 Common Law—Third Parties 698
Principles of Professional Conduct 653 Ordinary Negligence—Third-Party
Rules of Conduct 655 Claims 699
Independence, Integrity, and Fraud and Gross Negligence—Third-
Objectivity 656 Party Claims 705

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Damages under Common Law 706 Reporting on Management’s Assertion

Statutory Law—Civil Liability 706 about Internal Control 737
Securities Act of 1933 707 Financial Forecasts and Projections 737
Securities Exchange Act of 1934 709 Types of Prospective Financial
Private Securities Litigation Reform Statements 738
Act of 1995, the Securities Litigation Examination of Prospective Financial
Uniform Standards Act of 1998, and Statements 739
The Class Action Fairness Act of Agreed-Upon Procedures for Prospective
2005 712 Financial Statements 740
Sarbanes-Oxley Act of 2002 713 Compilation of Prospective Financial
SEC and PCAOB Sanctions 714 Statements 740
Foreign Corrupt Practices Act 716 Accounting and Review Services 742
Racketeer Influenced and Corrupt Compilation of Financial
Organizations Act 716 Statements 743
Statutory Law—Criminal Liability 717 Review of Financial Statements 744
Key Terms 718 Internal Auditing 746
Review Questions 719 Internal Auditing Defined 747
Multiple-Choice Questions 719 The Institute for Internal Auditors 747
Problems 722 IIA Standards 747
Discussion Cases 726 Code of Ethics 749
Hands-On Cases 726 Internal Auditors’ Roles 749
Internal Audit Product Offerings 752
PART 8 Interactions between Internal and
Assurance, Attestation, and External Auditors 752
Advanced Module: Examples of Assurance
Internal Auditing Services 727
Services—Trust Services and PrimePlus
Services 754
Chapter 21 Trust Services 754
Assurance, Attestation, and Internal CPA WebTrust 755
Auditing Services 729 SysTrust 757
Assurance Services 730 CPA PrimePlus Services 757
Types of Assurance Services 731 Key Terms 759
Attest Engagements 732 Review Questions 760
Types of Attest Engagements 733 Multiple-Choice Questions 760
Attestation Standards 734 Problems 763
General Standards 734 Discussion Case 767
Standards of Field Work 735 Internet Assignments 767
Standards of Reporting 735 Hands-On Cases 768
Reporting on an Entity’s Internal Control
over Financial Reporting 735 Professional Judgment Module (available
Conditions for Conducting an online at www.mhhe.com/messier8e)
Engagement 736
Examination Engagement 736 Index 769

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