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“Very accessible, especially for non-native English speaking students.” Rick Hayes Roger Dassen Arnold Schilder Philip Wallage
Ron Crijns, Haagse Hogeschool, The Netherlands Edition
“I found the book extremely easy to follow. In general I believe all the features of the book are very well AP
done. It seems to me there is a good balance in the difficulty of the student assignments: they range from n
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simple ‘repeat-the-book’ questions to more complex questions, requiring research and judgement. As an I
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all-purpose introduction to auditing with an international perspective, I believe the book is outstanding.” trIN
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“The book is easy to navigate and easy to handle. I think the questions, exercises and cases are excellent. tI
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The glossary is really excellent. This is the best glossary I have ever seen in an auditing textbook.”
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a structured approach to auditing principles using ISAs as its courses in auditing at undergraduate or postgraduate l
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basis. More and more, the International Standards on levels. It will also be of interest to accounting S
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standards. This book describes the development and practical International Standards on Auditing and recent
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University of Amsterdam and the University of ti
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Maastricht. He serves as a member on the International
Features: g
Auditing and Assurance Standards Board (IAASB).
• The ONLY principles of auditing textbook fully based
on ISAs. Dr Arnold Schilder is an Executive Director of the
Netherlands Central Bank and Chairman of the Basel
• Presents the latest auditing standards from a truly Committee of Banking Supervision’s Accounting Task
international perspective. Force, as well as Professor of Auditing at the University
• All audit concepts are illustrated with case study examples of Amsterdam. S H
from famous companies, such as Enron, Xerox, and Dr Philip Wallage is a Partner at KPMG, Amsterdam ch ay
WorldCom, bringing the subject to life. and Professor of Auditing at the University of i e
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experience as: practising professionals in auditing, a e
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regulation setter, an auditing standards setter, as well as
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Second Edition
PRINCIPLES OF AUDITING
An Introduction to International Standards on Auditing
Rick Hayes
California State University, Los Angeles
Roger Dassen
Deloitte Touche, Amsterdam
International Auditing and Assurance Standards Board (IAASB)
Free University of Amsterdam, University of Maastrict
Arnold Schilder
The Netherlands Central Bank
Basel Committee of Banking Supervisions Accounting Task Force
University of Amsterdam
Philip Walla ge
KPMG, Amsterdam
University of Amsterdam
Pearson Education Limited
Edinburgh Gate
Harlow
Essex CM20 2JE
England
and Associated Companies throughout the world
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First published by McGraw-Hill Publishing Company 1999
Second edition published by Pearson Education Limited 2005
Copyright © 1999 by McGraw-Hill International (UK) Limited
© Pearson Education Limited 2005
The rights of Rick Hayes, Roger Dassen, Arnold Schilder and Philip Wallage to be identified
as authors of this work have been asserted by them in accordance with the Copyright,
Designs, and Patents Act 1988.
All rights reserved. No part of this publication may be reproduced, stored in a retrieval
system, or transmitted in any form or by any means, electronic, mechanical, photocopying,
recording, or otherwise without either the prior written permission of the Publishers or a
licence permitting restricted copying in the United Kingdom issued by the Copyright
Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP.
The programs in this book have been included for their instructional value. They have been
tested with care but are not guaranteed for any particular purpose. The publisher does not
offer any warranties or representations nor does it accept any liabilities with respect to the
programs.
All trademarks used herein are the property of their respective owners. The use of any
trademark in this text does not vest in the author or publisher any trademark ownership
rights in such trademarks, nor does the use of such trademarks imply any affiliation
with or endorsement of this book by such owners.
ISBN 0 273 68410 8
British Library Cataloging-in-Publication Data
A catalogue record for this book is available from the British Library.
Library of Congress Cataloging-in-Publication Data
A catalog record for this book is available from the Library of Congress.
10 9 8 7 6 5 4 3 2 1
08 07 06 05
Typeset in 10.5/12.5 pt Minion by 25.
Printed and bound in Great Britain by Ashford Colour Press Ltd. Gosport.
The publisher’s policy is to use paper manufactured from sustainable forests.
Contents
List of illustrations xi
Foreword by xv
Preface xvii
Acknowledgements xix
1 International Auditing Overview 1
1.1 Learning Objectives 1
1.2 Auditing through World History 2
1.3 The Auditor, Corporations and Financial Information 3
1.4 International Accounting and Auditing Standards 5
1.5 An Audit Defined 10
1.6 Types of Audits 14
1.7 Types of Auditors 16
1.8 Setting Audit Objectives Based on Management Assertions 19
1.9 The Audit Process Model 23
1.10 International Public Accountancy Firms 28
1.11 Summary 33
1.12 Answers to Certification Exam Questions 35
1.13 Notes 35
1.14 Questions, Exercises and Cases 38
2 The Audit M arket 43
2.1 Learning Objectives 43
2.2 Introduction 44
2.3 Theories on the Demand and Supply of Audit Services 44
2.4 Audit Regulation 47
2.5 Audit Firms 50
2.6 Audit Quality and Audit Fee Determination 51
2.7 Legal Liability 52
2.8 Some Developments in the Audit Market 57
2.9 Examples of Landmark Studies and Legislation that Influenced the
International Audit Market 64
2.10 Summary 67
2.11 Answers to Certification Exam Questions 68
v
CONTENTS
2.12 Notes 69
2.13 Questions, Exercises and Cases 71
3 Ethics for Professional Accountants 74
3.1 Learning Objectives 74
3.2 What Are Ethics? 75
3.3 The IFAC Code of Ethics for Professional Accountants 76
3.4 Ethics Guidelines Applicable to All Accountants (Part A) 76
3.5 Ethics Applicable to Professional Accountants in Public Practice (Part B) 82
3.6 Independence Requirements 83
3.7 Other Topics Applicable To Professional Accountants in Public Practice 94
3.8 Applicable To Employed Professional Accountants (Part C) 101
3.9 Enforcement of Ethical Requirements 104
3.10 Future Developments 105
3.11 Summary 106
3.12 Answers to Certification Exam Questions 107
3.13 Notes 108
3.14 Questions, Exercises and Cases 110
4 An Auditor’s Services 113
4.1 Learning Objectives 113
4.2 International Framework for Auditor Services 114
4.3 Elements of an Assurance Engagement 117
4.4 General Considerations in An Assurance Engagement 124
4.5 Audits and Reviews of Historical Financial Information 126
4.6 Assurance Engagements Other than Historical Financial Information 136
4.7 Related Services 146
4.8 Summary 151
4.9 Answers to Certification Exam Questions 153
4.10 Notes 155
4.11 Questions, Exercises and Cases 160
5 Client Acceptance 164
5.1 Learning Objectives 164
5.2 Client Acceptance: the First Step on the Journey to an Opinion 165
5.3 Evaluate the Client’s Background 166
5.4 Ability to Meet Ethical and Specific Competence Requirements 171
5.5 Use of Other Professionals in the Audit 175
5.6 Communicating With the Predecessor (Existing) Auditor 178
5.7 Acceptance by the Client – The Engagement Proposal 179
5.8 The Audit Engagement Letter 183
vi
CONTENTS
5.9 Summary 186
5.10 Answers to Certification Exam Questions 187
5.11 Notes 188
5.12 Questions, Exercises and Cases 190
6 Understanding the Entity, Risk Assessment and Materiality 193
6.1 Learning Objectives 193
6.2 Planning – Phase II of the Audit Process Model 194
6.3 Understanding the Entity and its Environment 197
6.4 Based on the Evidence, Assess Risk; Types of Risk 208
6.5 Planning Materiality 215
6.6 Summary 220
6.7 Answers to Certification Exam Questions 222
6.8 Notes 223
6.9 Questions, Exercises and Cases 225
7 Internal Control and Control Risk 229
7.1 Learning Objectives 229
7.2 Introduction 230
7.3 Internal Control Defined 230
7.4 The Importance of Internal Control 232
7.5 Components of Internal Control 235
7.6 Control Environment 236
7.7 Risk Assessment 245
7.8 Information Systems, Communication, and Related Business Processes 247
7.9 Control Activities (Control Procedures) 251
7.10 Monitoring of Controls 256
7.11 Design of Internal Controls 259
7.12 Summary 261
7.13 Answers to Certification Exam Questions 263
7.14 Notes 264
7.15 Questions, Exercises and Cases 267
8 Control Risk, Audit Planning and Test of Controls 272
8.1 Learning Objectives 272
8.2 Understanding, Assessing and Testing Internal Controls 274
8.3 Understanding of Internal Controls and Documentation 274
8.4 Assessing Control Risk 286
8.5 Overall Responses to Assessed Risk 290
8.6 Prepare Planning Memorandum and Audit Plan 293
8.7 Tests of Controls 296
vii
CONTENTS
8.8 Evaluate Sufficiency and Appropriateness of Audit Evidence 304
8.9 Summary 305
8.10 Answers to Certification Exam Questions 307
8.11 Notes 309
8.12 Questions, Exercises and Cases 310
9 Analytical Procedures 317
9.1 Learning Objectives 317
9.2 Introduction 318
9.3 The Analytical Review Process 319
9.4 Formulating Expectations 324
9.5 General Analytical Procedures 326
9.6 Analytical Procedures During Different Phases In The Audit Process 333
9.7 Analytical Procedures As Substantive Tests 335
9.8 Computer Assisted Audit Techniques (CAATs) and
Generalized Audit Software (GAS) 337
9.9 Analytical Procedures Using Data Mining Techniques 341
9.10 Follow-Up In Case Of Unexpected Deviations 343
9.11 Summary 343
9.12 Answers to Certification Exam Questions 345
9.13 Notes 346
9.14 Questions, Exercises and Cases 348
10 Substantive Testing and Evidence 352
10.1 Learning Objectives 352
10.2 Introduction 353
10.3 The Basis of Evidence 354
10.4 Sufficient Appropriate Audit Evidence 358
10.5 Substantive Audit Procedures 364
10.6 Audit Proced ures for Obtaining Audit Evidence 368
10.7 Summary 380
10.8 Answers to Certification Exam Questions 382
10.9 Notes 384
10.10 Questions, Exercises and Cases 385
Appendix to Chapter 10
Audit Sampling and Other Selective Testing Procedures 391
10.A.1 Preface 391
10.A.2 Introduction 392
10.A.3 Definitions 392
10.A.4 Audit Evidence 397
10.A.5 Selecting Items for Testing to Gather Audit Evidence 400
10.A.6 Statistical versus Non-Statistical Sampling Approaches 401
viii
CONTENTS
10.A.7 Design of the Sample 402
10.A.8 Answers to Certification Exam Questions 417
10.A.9 Notes 418
10.A.10 Questions, Exercises and Cases 419
11 Completing the Audit 421
11.1 Learning Objectives 421
11.2 Introduction 423
11.3 Quality Control 424
11.4 Evaluate Governance Evidence 430
11.5 Review for Discovery of Subsequent Events 441
11.6 Review Financial Statements and Other Report Material 445
11.7 Wrap-Up Procedures 448
11.8 Going Concern Issues 455
11.9 Matters for Attention of Partners (MAPs) 457
11.10 Reports to The Board of Directors 458
11.11 Summary 460
11.12 Answers to Certification Exam Questions 461
11.13 Notes 463
11.14 Questions, Exercises and Cases 466
Appendix to Chapter 11
Audit Documentation and Working Papers 473
11.A.1 Introduction 473
11.A.2 Form and Content of the Working Papers 475
11.A.3 Document Retention 477
11.A.4 Permanent and Current Files 478
11.A.5 Preparation of Working Papers 483
11.A.6 Adjusting Entry 485
11.A.7 Summary 486
11.A.8 Notes 487
11.A.9 Questions, Exercises and Cases 489
12 Audit Reports and Communication 490
12.1 Learning Objectives 490
12.2 Introduction 491
12.3 Basic Elements of the Auditor’s Report 493
12.4 Types of Reports Expressing Audit Opinions 499
12.5 Matters that Do Not Affect the Auditor’s Opinion (Modification of an
Auditor’sReport Containing an Unqualified Opinion) 505
12.6 Circumstances That May Result in Other Than an Unqualified Opinion 511
12.7 Uncertainties Leading to Qualification of Opinions 516
12.8 Communications with those Charged with Governance 520
ix
