First Pages lou6920x_fm_i-xxxiv.indd i 04/21/20 09:20 PM Auditing & Assurance Services First Pages lou6920x_fm_i-xxxiv.indd ii 04/21/20 09:20 PM First Pages lou6920x_fm_i-xxxiv.indd iii 04/21/20 09:20 PM Timothy J. Louwers, PhD, CPA, CISA, CFF Professor Emeritus James Madison University Penelope L. Bagley, PhD, CPA Department Chair and Associate Professor of Accounting Appalachian State University Allen D. Blay, PhD, CPA Denise Dickins Accounting Faculty Fellow and Associate Professor Florida State University Jerry R. Strawser, PhD, CPA KPMG Chair of Accounting Texas A&M University Jay C. Thibodeau, PhD, CPA Rae D. Anderson Professor of Accounting Bentley University Auditing & Assurance Services First Pages lou6920x_fm_i-xxxiv.indd iv 04/21/20 09:20 PM AUDITING & ASSURANCE SERVICES, EIGHTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2021 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2018, 2015, and 2013. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 LWI 24 23 22 21 20 ISBN 978-1-260-36920-5 (bound edition) MHID 1-260-36920-X (bound edition) ISBN 978-1-260-70373-3 (loose-leaf edition) MHID 1-260-707373-8 (loose-leaf edition) Portfolio Manager: Elizabeth Eisenhart Product Developers: Erin Quinones Marketing Manager: Katherine Wheeler Content Project Managers: Mary E. Powers (core), Angela Norris (assessment) Buyer: Laura Fuller Design: Matt Diamond Content Licensing Specialists: Abbey Jones Cover Image: © Oskari Porkka/Shutterstock Compositor: SPi Global All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Names: Louwers, Timothy J., author. | Blay, Allen D., 1970- author. | Thibodeau, Jay C., author. | Strawser, Jerry R., author. | Bagley, Penelope, author. Title: Auditing & assurance services / Timothy J. Louwers, James Madison University, Allen Blay, Florida State University, Jay Thibodeau, Bentley University, Jerry Strawser, Texas A&M University, Penelope Bagley, Appalachian State University. Other titles: Auditing and assurance services Description: Eighth edition. | New York, NY : McGraw-Hill Education, 2021. | First edition entered under title. Identifiers: LCCN 2020010135 (print) | LCCN 2020010136 (ebook) | ISBN 9781260369205 (bound edition) | ISBN 9781260703733 (loose-leaf edition) ...

1. First Pages
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Auditing &
Assurance Services
First Pages
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First Pages
lou6920x_fm_i-xxxiv.indd iii 04/21/20 09:20 PM
Timothy J. Louwers, PhD, CPA,
CISA, CFF
Professor Emeritus James Madison University
Penelope L. Bagley, PhD, CPA
Department Chair and Associate
Professor of Accounting
Appalachian State University
Allen D. Blay, PhD, CPA
Denise Dickins Accounting Faculty

2. Fellow and Associate Professor
Florida State University
Jerry R. Strawser, PhD, CPA
KPMG Chair of Accounting
Texas A&M University
Jay C. Thibodeau, PhD, CPA
Rae D. Anderson Professor of
Accounting Bentley University
Auditing &
Assurance Services
First Pages
lou6920x_fm_i-xxxiv.indd iv 04/21/20 09:20 PM
AUDITING & ASSURANCE SERVICES, EIGHTH EDITION
Published by McGraw-Hill Education, 2 Penn Plaza, New York,
NY 10121. Copyright © 2021 by
McGraw-Hill Education. All rights reserved. Printed in the
United States of America. Previous editions
© 2018, 2015, and 2013. No part of this publication may be
reproduced or distributed in any form or by
any means, or stored in a database or retrieval system, without
the prior written consent of McGraw-Hill
Education, including, but not limited to, in any network or other
electronic storage or transmission, or
broadcast for distance learning.
Some ancillaries, including electronic and print components,
may not be available to customers outside

3. the United States.
This book is printed on acid-free paper.
1 2 3 4 5 6 7 8 9 LWI 24 23 22 21 20
ISBN 978-1-260-36920-5 (bound edition)
MHID 1-260-36920-X (bound edition)
ISBN 978-1-260-70373-3 (loose-leaf edition)
MHID 1-260-707373-8 (loose-leaf edition)
Portfolio Manager: Elizabeth Eisenhart
Product Developers: Erin Quinones
Marketing Manager: Katherine Wheeler
Content Project Managers: Mary E. Powers (core), Angela
Norris (assessment)
Buyer: Laura Fuller
Design: Matt Diamond
Content Licensing Specialists: Abbey Jones
Cover Image: © Oskari Porkka/Shutterstock
Compositor: SPi Global
All credits appearing on page or at the end of the book are
considered to be an extension of the
copyright page.
Library of Congress Cataloging-in-Publication Data
Names: Louwers, Timothy J., author. | Blay, Allen D., 1970-
author. |
Thibodeau, Jay C., author. | Strawser, Jerry R., author. |
Bagley,
Penelope, author.
Title: Auditing & assurance services / Timothy J. Louwers,
James Madison
University, Allen Blay, Florida State University, Jay

4. Thibodeau, Bentley
University, Jerry Strawser, Texas A&M University, Penelope
Bagley,
Appalachian State University.
Other titles: Auditing and assurance services
Description: Eighth edition. | New York, NY : McGraw-Hill
Education, 2021.
| First edition entered under title.
Identifiers: LCCN 2020010135 (print) | LCCN 2020010136
(ebook) | ISBN
9781260369205 (bound edition) | ISBN 9781260703733
(loose-leaf edition)
| ISBN 9781260703672 (ebook)
Subjects: LCSH: Auditing.
Classification: LCC HF5667 .A815 2021 (print) | LCC HF5667
(ebook) | DDC
657/.45—dc23
LC record available at https://lccn.loc.gov/2020010135
LC ebook record available at https://lccn.loc.gov/2020010136
The Internet addresses listed in the text were accurate at the
time of publication. The inclusion of a
website does not indicate an endorsement by the authors or
McGraw-Hill Education, and McGraw-Hill
Education does not guarantee the accuracy of the information
presented at these sites.
mheducation.com/highered
First Pages
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Some people come into our lives and quickly go. Some

5. stay awhile and leave footprints on our hearts and we
are never quite the same.
Anonymous
We dedicate this book to the following educators
whose footprints we try to follow:
Professor Homer Bates
(University of North Florida)
Professor Stanley Biggs
(University of Connecticut)
Professor Lewis C. Buller
(Indiana State University)
Professor Patrick Delaney
(Northern Illinois University)
Professor William Hillison
(Florida State University)
Professor John Ivancevich
(University of Houston)
Professor Richard Kochanek
(University of Connecticut)
Professor John L. “Jack” Kramer
(University of Florida)
Professor Jack Robertson
(University of Texas at Austin)
Professor Robert Strawser

6. (Texas A&M University)
Professor Sally Webber
(Northern Illinois University)
Professor “IBM Jim” Whitney
(The Citadel)
First Pages
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Meet the Authors
Timothy J. Louwers is Professor Emeritus at James Madison
University.
Professor Louwers received his undergraduate and master’s
degrees from The Citadel and
his PhD from Florida State University. Prior to beginning his
academic career, he worked
in public accounting with KPMG, specializing in financial,
governmental, and informa-
tion systems auditing. He is a certified public accountant (South
Carolina and Virginia)
and a certified information systems auditor. He is also certified
in financial forensics.
Professor Louwers’s research interests include auditors’
reporting decisions and ethi-
cal issues in the accounting profession. He has authored or
coauthored more than 60
publications on a wide range of accounting, auditing, and
technology-related topics,

7. including articles in the Journal of Accounting Research,
Accounting Horizons, the Jour-
nal of Business Ethics, Behavioral Research in Accounting,
Decision Sciences, the Jour-
nal of Forensic Accounting, Issues in Accounting Education, the
Journal of Accountancy,
the CPA Journal, and Today’s CPA. Some of his published work
has been reprinted
in Russian and Chinese. He is a respected lecturer on auditing
and technology-related
issues and has received teaching excellence awards from the
University of Houston and
Louisiana State University. He has appeared on both local and
national television news
broadcasts, including MSNBC and CNN news programs.
Allen D. Blay is an Associate Professor of Accounting and the
Denise Dickins
Accounting Faculty Fellow at Florida State University.
Professor Blay completed his PhD at the University of Florida
in 2000. He teaches auditing
at all levels and teaches a seminar in auditing research in the
doctoral program. His research
interests relate to auditor judgment and decision making.
Professor Blay has authored or
coauthored publications on a wide range of accounting and
auditing topics in journals
such as Contemporary Accounting Research, Auditing: A
Journal of Practice and Theory,
Organizational Behavior and Human Decision Processes, the
Journal of Business Eth-
ics, Behavioral Research in Accounting, Issues in Accounting
Education, the International
Journal of Auditing, and the Journal of Accounting, Auditing,
and Finance. He is currently

8. an editor for Issues in Accounting Education and serves on
several editorial boards.
Professor Blay has been active in the American Accounting
Association, co-chairing
the 2020 Auditing Section Midyear Meeting and serving on the
steering committee for
the Intensive Data and Analytics Summer Workshop the past
three years, as well as in
many other roles over the years. He is also active in the
American Institute of CPAs,
serving in various volunteer roles relating to the Uniform CPA
Exam. Prior to entering
academics, Professor Blay worked in public accounting auditing
financial institutions.
He currently directs the accounting doctoral program at Florida
State University.
Jerry R. Strawser is Executive Vice President and Chief
Financial Officer at
Texas A&M University and holds the KPMG Chair in
Accounting.
Prior to his current appointment, Professor Strawser served as
dean of Mays Business
School at Texas A&M University, interim executive vice
president and provost at Texas
A&M University, interim dean of the C. T. Bauer College of
Business at the University
of Houston, and Arthur Andersen & Co. Alumni Professor of
Accounting.
Professor Strawser has coauthored three textbooks and more
than 60 journal articles.
In addition to his academic experience, he had prior public
accounting experience at two

9. Big Four accounting firms. He has also developed and delivered
numerous executive
development programs to organizations such as AT&T,
Centerpoint Energy, Continental
Courtesy of James Madison
University
Courtesy of Kallen M. Lunt
Courtesy Jerry R. Strawser
First Pages
Meet the Authors vii
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Airlines, ConocoPhillips, Halliburton, KBR, KPMG, Minute
Maid, PricewaterhouseC-
oopers, McDermott International, Shell, Southwest Bank of
Texas, and the Texas Society
of Certified Public Accountants. Professor Strawser is a
certified public accountant in the
state of Texas and earned his BBA and PhD in Accounting from
Texas A&M University.
Jay C. Thibodeau is the Rae D. Anderson Professor of
Accounting and
Director of PhD Programs at Bentley University.
Professor Thibodeau is a certified public accountant and a
former auditor. He received
his bachelor’s degree from the University of Connecticut in

10. 1987 and his PhD from the
University of Connecticut in 1996. He joined the faculty at
Bentley in 1996 and has
remained there ever since. Professor Thibodeau has conducted
executive education pro-
grams for numerous leading firms including Fidelity
Investments, KPMG, Pricewater-
houseCoopers, Stryker, and Blue Coat Technologies.
Professor Thibodeau’s scholarship focuses on audit judgment
and decision making
and audit education. He is a coauthor of two textbooks and has
written more than 50
book chapters and articles for academics and practitioners in
journals such as Auditing: A
Journal of Practice & Theory, Journal of Information Systems,
Accounting Horizons and
Issues in Accounting Education.
Professor Thibodeau served as the president of the Auditing
Section of the American
Accounting Association for the 2014/2015 academic year. He
has received national rec-
ognition for his work six times: First, for his thesis, winning the
1996 Outstanding Doc-
toral Dissertation Award presented by the ABO section of the
AAA. Four other times, for
curriculum innovation, winning the 2001 Joint AICPA/AAA
Collaboration Award, the
2003 Innovation in Assurance Education Award, the 2016
Forensic Accounting Teaching
Innovation Award, and the 2019 Innovation in Assurance
Education Award. And finally,
for outstanding service, receiving a Special Service Award from
the Auditing Section for
his work in helping to create the Center for Audit Quality’s

11. Access to Auditors program.
Penelope L. Bagley is the Department Chairperson and
Professor of
Accounting at Appalachian State University.
Professor Bagley received her undergraduate and master’s
degrees from North Caro-
lina State University and her PhD at the University of Georgia.
Prior to obtaining her
PhD, Professor Bagley worked for a short time in the audit
field. She is a certified public
accountant in North Carolina. Professor Bagley teaches both
undergraduate and grad-
uate auditing courses. Professor Bagley has authored and co-
authored publications on
accounting and auditing topics in journals such as Auditing: A
Journal of Practice &
Theory, Accounting Horizons, and Behavioral Research in
Accounting. She has also co-
authored auditing cases, published in Issues in Accounting
Education. Professor Bagley
is active in the American Accounting Association and has
served on various committees
for the Auditing Section. In her spare time, Professor Bagley
likes to spend time with her
husband Matt and children, Garrett and Julianne. She is an avid
runner, most recently
qualifying and running the 2019 Boston Marathon.
Bentley University
Penelope L. Bagley

12. First Pages
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As auditors, we are trained to investigate beyond appearances to
determine the underly-
ing facts—in other words, to look beneath the surface. From the
Enron and WorldCom
scandals of the early 2000s to the financial crisis of 2007–2008
to present-day issues
and challenges related to significant estimation uncertainty,
understanding the auditor’s
responsibility related to fraud, maintaining a clear perspective,
probing for details, and
understanding the big picture are indispensable to effective
auditing.
With the availability of greater levels of qualitative and
quantitative information
(“Big Data”), the need for technical skills and challenges facing
today’s auditor is
greater than ever. The Louwers, Bagley, Blay, Strawser, and
Thibodeau team has dedi-
cated years of experience in the auditing field to this new
edition of Auditing & Assur-
ance Services, supplying the necessary investigative tools for
future auditors.
Cutting-Edge Coverage
The eighth 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

13. ∙ The latest professional standards, recodifications, and
proposals from the Interna-
tional Auditing and Assurance Standards Board, Auditing
Standards Board, and
Public Company Accounting Oversight Board.
∙ A list of the relevant professional standards that are covered
in that chapter, including
new AICPA reporting standards effective for 2020 fiscal years,
as well as compre-
hensive coverage of the new PCAOB standards on auditing
estimates.
Data Analytics
∙ One trend has emerged as a potential sea change in the
financial statement auditing
process: the data and analytics challenge.
We believe 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 and analytics
are frequently being used to describe a growing movement
among audit professionals.
As the AICPA moves to add data and analytics onto the
Uniform CPA Examination, our
collective view is that students must be able to not only meet
current requirements, but
be ahead of the game.
To prepare students, the eighth edition of Auditing & Assurance
Services has been
revised deliberately to help students critically think about the
use of increased data and

14. analytical tools in the financial statement audit. In addition to
changes within the main
chapters of the book, we have added
∙ A new module specifically covering data and analytics in
auditing, which follow-
sthe AICPA Guide to Data Analytics.
∙ Author-Created Cases and Exercises (as part of Data
Analytics Module) that cover
the majority of uses of data analytics in the financial statement
audit, along with
extensive solutions to help instructors implement the materials
in their classroom.
It is our belief that students should be trained in the process of
data and analytics, and
learn to think critically about situations they may face in an
audit. We believe that the
knowledge students attain should be software independent,
particularly since software
Look Beneath the Surface . . .
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technology changes so rapidly. However, we also believe that it
is important for stu-
dents to become familiar with at least one specific data and
analytic software tool, and

15. recent AACSB standards echo this belief. Thus, an important
goal of the eighth 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.
Many of our exercises,
however, can be implemented using whatever technology an
instructor chooses to use,
like Excel.
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 entry-level auditing professionals 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.
Perhaps most importantly, the eighth edition of Auditing &
Assurance Services also
continues to be the most up-to-date auditing text on the market.

16. The book has fully inte-
grated the new PCAOB and ASB reporting standards. In
addition, we fully cover
the PCAOB’s new standards on audits of estimates, including
fair value estimates,
and the use of specialists in an audit. In addition, all chapters
and modules have been
revised to incorporate the latest updates from the international
standards of audit-
ing (ISAs) and the Auditing Standards Board (ASB). With
Auditing & Assurance Ser-
vices, eighth edition, students are prepared to take on auditing’s
latest challenges.
The Louwers author team uses a conversational, yet
professional tone—hailed by
reviewers as a key strength of the book.
Flexible Organization
Auditing & Assurance Services teaches students auditing con-
cepts by emphasizing real-life contexts when describing the
auditing process. The authors use chapters and modules to
“The format allows you to integrate the
modules into the chapter material in
any way you would find useful.”
—Frank J. Beil, University of Minnesota
Chapters Modules
The 12 chapters cover the auditing
process extensively with a multitude of
cases designed to give students a better
understanding of how a best-practice
concept developed from real-world
situations.

17. Modules A–H provide instructors
additional material that can be used
throughout the course. Topics such as
fraud, ethics, sampling, and technology
are covered in the modules, which are
designed to be taught whenever instruc-
tors want to introduce the topic in their
course.
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lou6920x_fm_i-xxxiv.indd x 04/21/20 09:20 PM
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.
Engage Your Students with Real Examples
An effective accounting textbook integrates real-world
scenarios with theoretical discus-
sion. Auditing & Assurance Services places the student in the
role of a decision maker,
by illustrating the application of auditing concepts using actual

18. situations experienced
by accounting firms and companies such as:
∙ Each chapter or module opens with a “real-world” example
that draws upon concepts
discussed within that chapter or module.
∙ A series of mini-cases available on the Instructor Resource
Center have been devel-
oped for use by instructors to further bring text material to life.
These mini-cases fea-
ture real situations experienced by companies, individuals, or
accounting firms and
are updated by the authors to include both timeless classics such
as Arthur Andersen’s
failure to detect fraud at Enron to more recent situations such as
Lehman Brothers.
Fraud Awareness
The fraud coverage in Auditing & Assurance Services
is the most extensive available and is complemented by
real-world examples chosen to engage students through
the following tools:
Confirming Pages
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LEARNING OBJECTIVES
The professional standards emphasize the importance
of an auditor’s identification and assessment of the
risks of material misstatement that exist related to an
audit client. Once each of the risks is identified and
assessed, the auditor needs to plan an appropriate

19. response. Given the importance of risk assessment,
it is not surprising that the professional standards
state that the risk assessment process underlies the
entire audit process. In Chapter 3, we covered the
engagement planning process, beginning with pre-
engagement activities, supervision, and materiality.
In this chapter, we provide comprehensive coverage
of an auditor’s risk assessment and its impact on the
audit process.
Risk comes from not knowing what you’re doing.
Warren Buffett.
Profit is the result of risks wisely selected.
Frederick Barnard Hawley.
The Audit Risk Model
and Inherent Risk
Assessment
C H A P T E R 4
Professional Standards References
Topic
AU-C/ISA
Section AS Section
Consideration of Fraud in a Financial Statement Audit 240 2401
Consideration of Laws and Regulations 250 2405
Communications with Audit Committees 260 1301

20. Audit Planning 300 2101
Identifying and Assessing the Risks of Material Misstatement
315 2110
Materiality 320 2105
Auditors’ Responses to Risks of Material Misstatement 330
2301
Audit Evidence 500 1105
Substantive Analytical Procedures 520 2305
Related Parties 550 2410
∙ Auditing Insights integrated throughout the text.
∙ Apollo Shoes Case, the only stand-alone fraud audit
case on the market (available online).
∙ Mini-cases that may be assigned to supplement
text chapters and modules that expose students
to landmark fraud cases at Bernie Madoff Investment
Securities, Enron, HealthSouth,
Parmalat, PTL Club, and Satyam Computer Services.
∙ Specific discussion of management fraud (Chapter 4),
employee fraud (Chapter 6),
and the Certified Fraud Examiner Exam (Module D).
First Pages

21. xi
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Create a State-of-the-Art Learning Environment:
Instructor Resources
The author team and McGraw-Hill are dedicated to providing
instructors with the best
teaching resources available. In addition to the solutions
manual, test bank, PowerPoint
Presentations, and the Apollo Shoe Case, the following
resources are also available.
The Updated Auditor
The author team scrutinizes leading business and academic
publications for relevant
issues and research that sheds light on auditing and the audit
process. Recent findings
from academic research and discussions from professional
literature are drawn from the
following publications:
∙ Accounting Horizons
∙ Accounting Today
∙ Auditing: A Journal of Practice & Theory
∙ Behavioral Research in Accounting
∙ Bloomberg Businessweek
∙ CFO.com
∙ CPA Journal
∙ Journal of Accountancy
∙ Journal of Accounting and Economics
∙ The Accounting Review
∙ The Wall Street Journal
These excerpts are highlighted throughout the text as Auditing

22. Insights to allow for
easy identification and review by instructors and students.
In addition to the use of Auditing Insights, on a monthly basis,
the author team pro-
vides an Updated Auditor briefing, which summarizes the
content of relevant business
and academic publications on a chapter-by-chapter basis, to
allow students to apply cur-
rent developments in the profession with material discussed in
class. The Updated Audi-
tor briefing is available in Connect. With the Updated Auditor,
instructors will always
be at the cutting edge of auditing practice!
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), both modules on sam-
pling (Modules E and F), and the new data and analytics module
(Module G) have been
revised to reference the use of IDEA within the chapter or
module.
First Pages

23. xii
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In addition, the eighth edition includes end-of-chapter exercises
utilizing author-
developed databases exclusively for use with Auditi ng &
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.
∙ Robust video walk-throughs.
∙ Detailed solutions and explanations on this new content.
Overall, the author team has provided significant resources to
prepare students for the
auditing environment in 2020 and beyond.
Roger CPA Review
McGraw-Hill has partnered with Roger CPA Review (Powered
by UWorld), a global
leader in CPA Exam preparation, to provide students a smooth
transition from the
accounting classroom to successful completion of the CPA
Exam. While many aspiring
accountants wait until they have completed their academic
studies to begin preparing
for the CPA Exam, research shows that those who become
familiar with exam content
earlier in the process have a stronger chance of successfully
passing the CPA Exam.

24. Accordingly, students using these McGraw-Hill materials will
have access to Roger
CPA Review multiple choice questions supported by
explanations written by CPAs
focused on exam preparation. McGraw-Hill and Roger CPA
Review are dedicated
to supporting all accounting students along their journey,
ultimately helping them
achieve career success in the accounting profession. For more
information about the
full Roger CPA Review program, exam requirements, and exam
content, visit
www.rogercpareview.com.
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.
gvedanayaki
Callout
Could you please check the image size and placement here. Let
us know if changes needed.

25. First Pages
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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, 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
eight general knowledge and skill guidelines in the AACSB
standards. The statements
contained in Auditing & 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, their mission, and their
faculty. Although Audit-
ing & Assurance Services, 8e, and the teaching package make
no claim of any specific
AACSB qualification or evaluation, we have within Auditing &
Assurance Services,
8e, labeled selected questions in Connect according to the eight
general knowledge and
skills areas.
First Pages

26. xiv
lou6920x_fm_i-xxxiv.indd xiv 04/21/20 09:20 PM
New to the Eighth Edition of
In response to feedback and guidance from numerous
auditing accounting faculty, the authors have made
many important changes to the eighth edition of Audit-
ing & Assurance Services, including the following:
∙ The eighth edition of Auditing & Assurance Ser-
vices features Connect and SmartBook.
∙ A new Module G has been added to include full cov-
erage of the uses of Data and Analytics in auditing,
including extensive Data Analytics Exercises with
author-created data.
∙ All chapters and modules have been revised to
incorporate professional standards adopted through
January 2020.
∙ New Update to Apollo Shoes, Inc. case with Data
Analytics content. Apollo Shoes, Inc. is an audit
case designed to introduce students to the entire
audit process. Newly created auto-gradable ques-
tions, instructor implementation guide, and videos
can be found online in Connect.
∙ Auditing Insight boxes have been added and
updated throughout the textbook to place issues
The following breakdown shows the revisions we
made on a chapter-by-chapter basis:

27. CHAPTER 1: Auditing and Assurance Services
∙ Updated the section on the importance of reliable
information for users by incorporating a discus-
sion about Theranos, the blood-testing startup
company that was recently featured in an HBO
movie. In many cases, the informational package
provided to potential investors did not include an
independent audit report. The example reinforces
why it is so important for investors and creditors to
review audited financial statements as they consider
whether to invest or loan money to a company.
∙ Included a new Auditing Insight featuring the most
recent audit quality report published by KPMG.
Importantly, the report highlighted the firm’s invest-
ment in the audit of the future and included a dis-
cussion of cognitive technologies such as IBM’s
Watson and the importance of harnessing the emerg-
ing power of Big Data.
∙ Included a new Auditing Insight that describes
the role of EY, a Big Four accounting firm, in the
the annual Hall of Fame voting for baseball. That
is, while the the Baseball Writers’ Association of
America is responsible for the voting, EY is respon-
sible for verifying that eligible voters are properly
registered and have signed a code of conduct, and
that the actual count of votes is correct!
CHAPTER 2: Professional Standards
∙ Added opening vignette describing the Deloitte Bra-
zil audits of Gol Intelligent Airlines and alteration of
documentation in response to a PCAOB inspection.

28. ∙ Added Auditing Insights related to the Carillion
audit failure, the United Kingdom Competition and
Markets Authority recommendations for auditor
independence, and the KPMG controversy related to
advance notification of audits selected for PCAOB
inspection.
∙ Included a summary of recent academic research
relating to the impact of PCAOB inspection results
discussed within the text into a real-world context.
These boxes incorporate numerous examples from
business and academic publications as well as actual
company annual reports and audit reports.
∙ Examples using the Caseware IDEA software are
included in Chapters 3, 4, 5, 7, 8, 9, Module F, and the
new Module G focusing on Data and Analytics. In
addition, end-of-chapter exercises using author-devel-
oped databases exclusively for use with Auditing &
Assurance Services as well as supplemental materials
to complement the IDEA workbook are provided.
∙ Tables in the cycle chapters have been fully standard-
ized to focus on the risk assessment process for each
relevant assertion. The chapters provide a consistent
focus on how auditors respond to assessed risk of
material misstatement, through the incorporation of
easy-to-read tables throughout Chapters 6 through 10
to highlight the key issues and risks faced by audi-
tors in the examination of different accounts. These
tables take the students through the risk assessment
process for each cycle on a step-by-step basis to mir-
ror the methodology used in current audit practice.
Highlights of Auditing & Assurance Services, 8e

29. Part I: The Contemporary Auditing Environment
First Pages
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lou6920x_fm_i-xxxiv.indd xv 04/21/20 09:20 PM
on auditor dismissal, auditor market share and fees,
auditor opinions, audit quality, and audit effort in
years following the inspection.
∙ Included 2019 auditors’ report for Microsoft, one of
the first major companies to be subject to disclosure
of critical audit matters in the auditors’ report.
∙ Summarized PCAOB inspections of 2014, 2015,
and 2016 audits conducted by Big Four firms and
expanded analysis to summarize the number of
audits in which the client’s report on internal control
was revised as a result of the inspection.
Auditing & Assurance Services
CHAPTER 3: Engagement Planning
∙ Updated planning discussion for changes related to
the updated PCAOB Auditing Standard 1210: Using
the Work of an Auditor-Engaged Specialist, effective
for FYE 12/15/2020 and amendments to Auditing
Standard 1105: Audit Evidence and Audit Standard
1201: Supervision of the Audit Engagement.

30. ∙ Integrated discussion of matters of planning related
to the client’s computer environment and the use
of CAATs (former LO 3-5) into the chapter and
remainder of the text.
∙ Introduced a new vignette reflecting current audit
environment and independence concerns.
∙ Rearranged and updated discussions on Staffing the
Audit Engagement and Materiality for readability
and flow.
∙ Updated and replaced Audit Insights and examples
throughout the chapter to reflect more recent events.
CHAPTER 4: The Audit Risk Model and Inherent
Risk Assessment
∙ Renamed the chapter to better reflect the chapter
content.
∙ Introduced a new vignette discussing recent PCAOB
inspection reports and their continued focus on
issues related to audit risk assessment.
∙ Added a discussion in Inherent Risk Assessment to
reflect the need for the auditor to also understand the
client’s computerized processing when gaining an
understanding of the client’s business and environment.
∙ Replaced and updated Audit Insights and examples
throughout the chapter to reflect more recent events.
CHAPTER 5: Risk Assessment: Internal Control
Evaluation
∙ Revised the introduction to include the recent “cease

31. and desist” orders issued by the SEC (January 2019)
against four public companies: Lifeway Foods Inc.,
Digital Turbine Inc., CytoDyn Inc., and Grupo Simec
S.A.B de C.V. After providing each of these compa-
nies with as many as 10 years to address their prob-
lems, the SEC finally had enough and decided to take
action. In taking this action, the SEC made clear that
“disclosure of material weaknesses is not enough
without meaningful remediation. We are commit-
ted to holding corporations accountable for failing to
timely remediate material weaknesses.” The introduc-
tion allows for instructors to emphasize the impor-
tance of the internal control audit in their classes
∙ Added an Auditing Insight that featured, Elon Musk,
the billionaire co-founder of Tesla Inc., who was fined
$20 million by the SEC for a seemingly harmless tweet
that he made on August 7, 2018. The tweet indicated
that he had secured financing to take the company pub-
lic, causing an increase of over six percent in the com-
pany’s stock price. The basis of the SEC’s complaint
against Tesla related back to a lack of internal controls.
∙ Replaced the dated Krispy Kreme management
report on Internal Control over Financial Reporting
with excerpts from a Costco Wholesale Corporation
management report on internal control over financial
reporting, which identified a material weakness in
its system of internal control. The material weakness
related to information technology general controls
which serves to reinforce the importance of informa-
tion technology controls in today’s audit environ-
ment. The report was issued on October 26, 2018.

32. CHAPTER 6: Employee Fraud and the Audit of Cash
∙ Updated the discussion on bank cash confirmations
to include a detailed description of the process and
an example of electronic confirmation using Confir-
mation (formerly Confirmation.com).
∙ Added multiple new and current Auditing Insights
focusing on recent interesting frauds involving the
misuse of cash within an organization, including an
insightful and somewhat humorous story involving
lunch ladies at a school cafeteria.
Part II: The Financial Statement Audit
First Pages
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lou6920x_fm_i-xxxiv.indd xvi 04/21/20 09:20 PM
∙ Revised the end-of-chapter content to address elec-
tronic bank confirmations.
CHAPTER 7: Revenue and Collection Cycle
∙ Included a new section with details surrounding
the audit of revenue recognized in accordance with
ASC 606. The section discusses the five-step rev-
enue recognition process and how auditors approach
the issues involved.
∙ Included a new introduction to the chapter that
discusses the recent Carillion fraud and the issues

33. involved with estimation of revenue under longer-
term revenue contracts.
∙ Added a comprehensive end-of-chapter exercise
involving a substantive analytical procedure for
auditing ticket revenue for a university. The exercise
requires students to consider issues related to suf-
ficiency of evidence and precision of data.
∙ Updated PCAOB inspection findings through the
latest inspection reports.
∙ Included several new data and analytics exercises
in the new Module G related to revenue recogni-
tion, along with several existing author-created and
IDEA workbook exercises, enabling instructors to
have many options for integration of data analytics
into their courses.
CHAPTER 8: Acquisition and Expenditure Cycle
∙ Substantially revised all tables in the chapter to be
identical in format for all cycle chapters (6-10). This
enables instructors to present a common format that
matches the current method of auditing, from iden-
tification of significant accounts and relevant asser-
tions to substantive procedures to audit residual risks.
∙ Added multiple new auditing insights covering cur-
rent news related to auditing the expenditure cycle.
∙ The end of chapter materials contain a new CPA
Exam-style simulation that requires students to link
audit issues to assertions, control procedures, and
substantive procedures to match the new increase
emphasis of these areas on the CPA Exam.

34. CHAPTER 9: Production Cycle and the Audit of
Inventory
∙ Revised the chapter to focus on the audit of the
inventory account, no longer primarily focusing on
the production cycle. The chapter addresses risks of
material misstatement in the inventory account for
companies ranging from manufacturers to retailers
such as Target.
∙ Substantially revised all tables in the chapter to be
identical in format for all cycle chapters (6–10).
This enables instructors to present a common format
that matches the current method of auditing, from
identification of significant accounts and relevant
assertions to substantive procedures to audit residual
risks.
∙ End-of-chapter materials include a new CPA Exam–
style simulation involving issues in an inventory
count. An additional new end-of-chapter exercise
involves fraud detection in an audit of inventory.
∙ New data and analytic exercises included with
Module G focus on issues related to audits of the
inventory account. The chapter continues to include
a focus on data and analytics that integrates several
IDEA exercises, including author-created content
and end-of-chapter materials.
∙ Updated PCAOB inspection findings to focus on
current issues being addressed in inspection reports.
CHAPTER 10: Finance and Investment Cycle
∙ Significantly expanded the discussion of audit-

35. ing accounting estimates, including fair values,
to address the newly revised PCAOB standards.
In addition, added a much more detailed discus-
sion of the general approach to auditing accounting
estimates.
∙ Updated tables throughout the chapter to include
examples involving auditing accounting estimates in
investment accounts.
∙ Included in the introduction a new discussion of the
very recent (August 2019) accusations of GE by
Harry Markopolos. The introduction allows students
to consider the difficult issues involved in auditing
the finance and investment cycle and how the audi-
tor may have approached these issues.
CHAPTER 11: Completing the Audit
∙ Updated discussion of Ability to Continue as a
Going Concern for updates to PCAOB Auditing
Standard 2415 and AICPA AU-C 570, The Audi-
tor’s Consideration of an Entity’s Ability to Con-
tinue as a Going Concern.
∙ Updated introductory vignette to reflect current state
of Valeant (now Bausch Health).
∙ Abbreviated Attorney Letter and Written Represen-
tations sections to include most relevant material.
∙ Replaced and updated Audit Insights and examples
throughout the chapter to reflect more recent events.

36. First Pages
xvii
lou6920x_fm_i-xxxiv.indd xvii 04/21/20 09:20 PM
MODULE A: Other Public Accounting Services
∙ Significantly streamlined and reorganized presen-
tation into four major sections addressing special
issues in GAAS audits, other attestation engage-
ments, accounting and review service engagements,
and assurance engagements.
∙ Expanded coverage of audits of financial statements
prepared using a special purpose framework and
prospective financial information.
∙ Added Auditing Insights relating to the required
scope of agreed–upon-procedures engagements
required by the National Collegiate Athletics Asso-
ciation, PCAOB sanctions relating to broker–dealer
compliance, deficiencies from a PCAOB inspection
report related to the use of service auditor’s reports,
trends in corporate responsibility reporting, and
BDO’s assurance on Amazon Trust Services’ Certi-
fication Authority operations.
∙ Incorporated tables and other pedagogical summa-
ries throughout module to provide overview of key
differences in scope of engagements and accoun-
tants’ reports across different types of engagements.
∙ Significantly expanded end-of-chapter materials,
including a number of Connect-gradable assignments.

37. MODULE B: Professional Ethics
∙ Added an Auditing Insight to illustrate the General-
ization argument featuring the data breach at Equi-
fax, the largest data breach in history. The breach
resulted in the names, addresses, and social secu-
rity numbers of over 147 million Americans being
stolen. The data breach occurred in May 2017 but
wasn’t discovered by Equifax until July 29th, nearly
two months later. It took the company another six
weeks to notify the public that names and Social
Security numbers of millions had been stolen. In
the aftermath, the SEC brought charges against for-
mer Equifax Chief Information Officer Jun Ying
in March of 2018 for using his knowledge of the
breach to sell shares of the company’s stock before
the breach was made public.
∙ Added two new key terms, independence in fact and
independence in appearance. Article IV of the AIC-
PA’s Professional Code of Conduct requires that “a
member in public practice should be independent in
fact and appearance when providing auditing and
other attestation services.” As a result, it was impor-
tant to feature these concepts as key terms.
∙ Added an Auditing Insight that describes how Price-
waterhouseCoopers (PwC) lost Alteryx as an audit
client over independence concerns. Alteryx is a soft-
ware company that was being used by PwC. As a
result of their promotion of the software to their cli -
ents, executives at Alteryx became concerned about
the independence of their auditing firm. As such,
they replaced PwC with Deloitte.

38. MODULE C: Legal Liability
∙ Added a new introductory vignette on litigation
involving PwC for its audits of Colonial Bank and
resulting settlement with the FDIC.
∙ Updated the summary of major settlements involv-
ing Big Four accounting firms to include more
recent settlements.
Part III: Stand-Alone Modules
CHAPTER 12: Reports on Audited Financial
Statements
∙ Revised chapter and end-of-chapter materials to incor-
porate the revised auditors’ report for non-issuers
required by Statement on Auditing Standards No. 134.
∙ Added Auditing Insight relating to recent issues
regarding the use of component auditors (U.K. affiliate
firms’ involvement in the audits of Amazon, Black-
Rock, and Citigroup; KPMG, Deloitte, and BDO’s use
of Zimbabwe affiliate firms; and Deloitte’s use of mul -
tiple component auditors in the audit of Monsanto).
∙ Added examples from auditors’ reports issued for
Alphabet, Caesars Entertainment Corporation,
DowDupont, Fannie Mae, Freddie Mac, General
Electric, General Motors, Kraft Heinz Company,
Tesla Inc., and YUM! Brands.
∙ Added appendix related to auditors’ reports on
financial statements and reports on internal con-

39. trol over financial reporting for issuers, including
information relating to the topics included as criti-
cal audit matters in the early round of auditors’
reports.
∙ Provided supplemental auditors’ reports and end-of-
chapter materials in Connect for instructors wishing
more extensive coverage of auditors’ reporting for
issuers and the PCAOB audit report.
First Pages
xviii
lou6920x_fm_i-xxxiv.indd xviii 04/21/20 09:20 PM
∙ Expanded the discussion of academic research
examining auditor litigation to include recent stud-
ies that investigated the factors affecting the litiga-
tion risk faced by audit firms.
∙ Replaced and updated Audit Insights and examples
throughout the module to reflect more recent events.
MODULE D: Internal Audits, Governmental Audits,
and Fraud Examinations
∙ New introductory vignette highlighting 2018 Atlanta
cyber attack and the importance of the internal audit
role and recommendations.
∙ Restructured learning objectives to include only
three similar objectives focused on each of the three
areas highlighted in the module, Internal Audits,

40. Governmental Audits, and Fraud Examinations.
∙ Reorganized discussions of Internal Audits and
Governmental Audits. Aligned the discussions to
include similar topic headings including definition,
types of services, standards, and reports.
∙ Consolidated review checkpoints to appear at the
end of each of the three major sections; added three
new review checkpoints for Internal Audits.
∙ Replaced and updated Audit Insights and examples
throughout the module to reflect more recent events.
MODULES E and F: Sampling
∙ Focused sampling modules on applications of attri-
butes (Module E) and variables (Module F) sampling,
while integrating CPA-exam specific concepts and
terminology from the former overview module as
appropriate.
∙ Reoriented Modules E and F to illustrate how results
from an attributes sampling application influence
the necessary level of detection risk and variables
sampling application.
∙ Included vignette in Module E to illustrate how polls in
the 2017 United Kingdom “snap” election, 2016 Brexit
vote, and 2016 United States presidential election were
subject to sampling risk and emphasize the importance
of controlling sampling risk in the audit examination.
∙ Included IDEA screen captures within modules to
illustrate the identification and input of parameters
as well as the evaluation of sample results.

41. ∙ Expanded number of Connect-gradable assignments
in end-of-chapter materials.
MODULE G: Data and Analytics in Auditing
∙ A new module addresses the key questions stu-
dents have about what Data and Analytics are in
an auditing context, and how audit procedures using
these techniques should be conducted. The module
follows the approach from the AICPA Guide to
Data Analytics in Auditing.
∙ The module contains an extended discussion of infor-
mation produced by the entity (IPE) and how the audi-
tor should assess the completeness and accuracy of
this information, as well as the precision of the infor-
mation for the purposes of the auditing procedure.
∙ The end of chapter multiple choice, exercises and
problems contain entirely author-created questions and
examples, as well as significant assistance for instruc-
tors for implementing the exercises in their classrooms.
∙ Exercises and problems are linked to learning
objectives in other chapters in the book to enable
instructors to appropriately integrate the important
topic of data and analytics throughout the auditing
curriculum.
MODULE H: Auditing and Information Technology
∙ Given that the use of information technology (IT)
is pervasive in the financial reporting process on
largely all audit clients in today’s environment, audi-

42. tors must gain an understanding of how IT is used in
the internal control system. This is now explained
in detail in Module H with a focus on three phases:
(1) determining the scope of the IT testing plan by
carefully identifying each of the IT dependencies;
(2) understanding the IT controls and processes that
need to be tested for each IT dependency; and (3)
testing the IT controls.
∙ In today’s audit environment, to help facilitate the
identification of IT dependencies, as key internal
control activities are identified and understood by
auditors, they are generally categorized as being: (1)
purely manual control activities; (2) manual control
activities that rely on a system generated report; or
(3) entirely automated controls. Each of these cat-
egories is now described in detail in Module H.
∙ We increased our coverage of a commonly used
form of reperformance testing referred to as the test
data approach. When using this approach, the audi-
tor will create a set of data to simulate a series of
transactions that contain known errors in order to
test whether the client’s IT control activity is operat-
ing effectively. In the revised module, we included
a commonly used example known as the test of one
where auditors test a three-way match control in
either the revenue or the purchasing process.
FOR INSTRUCTORS
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45. FOR STUDENTS
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First Pages
xxii
lou6920x_fm_i-xxxiv.indd xxii 04/21/20 09:20 PM
Dawn P. Addington
Central New Mexico Community College
Michael D. Akers
Marquette University
Fatima Alali
California State University–Fullerton
Sylvia Anderson
University of Maryland University
College
Jeffrey J. Archambault
Marshall University

48. Jack Armitage
University of Nebraska–Omaha
MaryAnne Atkinson
Central Washington University
Dereck D. Barr
The University of Mississippi
LuAnn Bean
Florida Institute of Technology
Frank J. Beil
University of Minnesota
Marie Blouin
Penn State University–Harrisburg
David Blum
Moraine Park Technical College
Russell F. Briner
University of Texas at San Antonio

49. Alexander K. Buchholz
Brooklyn College of the City University
of New York
Suzanne M. Busch
California State University–East Bay
Eric Carlsen
Kean University
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.

50. 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 eighth edition, which significantly enhances the
practical application of
the book.
Also, the authors are particularly grateful to Ryan Dunn
(Auburn University),
Meghann Cefaratti (Northern Illinois University), Brad Roof
(James Madison Univer-
sity), and Yigal Rechtman (Pace University) for their many
insightful comments over
the past several years. The feedback they contributed 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 Cristina Alberti for
her input on Module H. In addition, thanks to Steven Dwyer,
Suzanne McLaughlin, and
Frank Wimer for the example developed to help explain the

51. difference between general
and application controls in Module H. Thanks to Helen Roybark
for her help with the
preparation of the instructor PowerPoint presentations and
Joleen Kremin for her contri-
bution to the Apollo Shoes, Inc. case.
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:
Acknowledgments
First Pages
Acknowledgements xxiii
lou6920x_fm_i-xxxiv.indd xxiii 04/21/20 09:20 PM
Meghann Cefaratti
Northern Illinois University

52. John Critchett
Madonna University
Karl Dahlberg
Rutgers University
John E. Delaney
Southwestern Texas University
Marcus Mason Doxey
University of Kentucky
Raymond Elson
Valdosta State University
Tom English
Boise State University
Patricia Feller
Nashville State Community College
Marilyn Fisher
Corinthian Colleges
Diana R. Franz

53. University of Toledo
John Gabelman
Columbus State Community College
Clyde Galbraith
West Chester University
Andy Garcia
Bowling Green State University
David Gelb
Seton Hall University
Earl Godfrey
Gardner-Webb University
Judith G. Grant
Northern Virginia Community College at
Annandale
Emily Elaine Griffith
The University of Georgia
Richard Hale

54. Midway College
James Hansen
University of Illinois at Chicago
Aretha Hill
Florida A&M University
Steven C. Hunt
Western Illinois University
Venkataraman Iyer
The University of North Carolina at
Greensboro
Keith Jones
George Mason University
Bonita K. Peterson Kramer
Montana State University–Bozeman
Joseph M. Larkin
St. Joseph’s University
Rose Layton

55. University of Southern California
Pamela Legner
College of DuPage
Philip Levine
Berkeley College
R. D. Licastro
Penn State University–University Park
Maureen Mascha
Marquette University
Dorothy McMullen
Rider University
Heidi H. Meier
Cleveland State University
Bharat Merchant
Baruch College
Eddie Metrejean
Georgia Southern University

56. Charles Miller
California Polytech University
Perry Moore
Lipscomb University
Fowler A. Murrell
Lehman College
Ramesh Narasimhan
Montclair State University
Vincent Owhoso
Northern Kentucky University
Dwight M. Owsen
Long Island University Brooklyn
Gary Peters
University of Arkansas
Byron Pike
Minnesota State University–Mankato

57. Marshall Pitman
University of Texas–San Antonio
Sharon Polansky
Texas A&M University–Corpus Christi
First Pages
xxiv Acknowledgements
lou6920x_fm_i-xxxiv.indd xxiv 04/21/20 09:20 PM
In addition, we would like to recognize our outstanding staff at
McGraw-Hill: Manag-
ing Director, Tim Vertovec; Brand Manager, Elizabeth
Eisenhart; Marketing Manager,
Kate Wheeler; Core Product Developer, Erin Quinones;
Assessment Product Developer,
Allie Kukla; Content Project Managers, Mary Powers and
Angela Norris; Buyer, Laura
Fuller; and Designer, Matt Diamond. For their encouragement,
assistance, and guidance
in the production of this book, we are grateful.

58. Kathy Pollock
Indiana University–Purdue University
Fort Wayne
Duane Ponko
Indiana University of Pennsylvania
Dwayne Powell
Arkansas State University
Abdul Qastin
North Carolina A&T State
Linda Quick
University of South Carolina
Hema Rao
SUNY–Oswego
Jason T. Rasso
University of South Florida
Yigal Rechtman
Pace University

59. Tracy Reed
Appalachian State University
Barbara Reider
University of Montana
Raymond Reisig
Pace University
John Rigsby
Mississippi State University
Pamela Roush
University of Central Florida
Maria Sanchez
Rider University
Kristen Kelli Saunders
University of South Carolina
Tammi Schaefer
University of South Carolina

60. Bunney L. Schmidt
Utah Valley State College
Timothy Andrew Seidel
University of Arkansas
Carol Shaver
Louisiana Tech University
Jaysinha Shinde
Eastern Illinois University
Adrianne Slaymaker
Metropolitan State University
Duane Smith
Brescia University
Beverly Strachan
Troy University at Montgomery
Iris Stuart
California State University
Christine N. Todd

61. Colorado State University–Pueblo
John Trussel
Penn State University–Harrisburg
Jerry L. Turner
University of Memphis
Frank Venezia
State University at Albany
Barbara Vinciguerra
Moravian College
Bobby Waldrup
University of North Florida
Rick Warne
University of Cincinnati
J. Donald Warren Jr.
Rutgers University
Christian Wurst
Temple University

62. Tu Xu
Georgia State University
Xu Zhaohui
University of Houston–Clear Lake
Lin Zheng
Northeastern Illinois University
Douglas Ziegenfuss
Old Dominion University
First Pages
Acknowledgements xxv
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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

63. 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;
Matt, Garrett, and Julianne Bagley; Kristin, Jackson, Elijah,
Jonah, Ansley, and Laney
Grace Blay; 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
Pennie Bagley
Allen Blay
Jerry Strawser

64. Jay Thibodeau
First Pages
xxvi
lou6920x_fm_i-xxxiv.indd xxvi 04/21/20 09:20 PM
12. Reports on Audited Financial
Statements 537
PART THREE
Stand-Alone Modules
Please refer to pages xviii–xxiii for guidance
on when to best integrate these modules.
A. Other Public Accounting Services 593
B. Professional Ethics 631
C. Legal Liability 679
D. Internal Audits, Governmental Audits, and

65. Fraud Examinations 721
E. Attributes Sampling 757
F. Variables Sampling 796
G. Data and Analytics in Auditing 845
H. Information Technology Auditing 881
INDEX 922
PART ONE
The Contemporary Auditing Environment
1. Auditing and Assurance Services 1
2. Professional Standards 41
PART TWO
The Financial Statement Audit
3. Engagement Planning and Audit
Evidence 78
4. The Audit Risk Model and Inherent Risk
Assessment 117
5. Risk Assessment: Internal Control
Evaluation 172

66. 6. Employee Fraud and the Audit of Cash 220
7. Revenue and Collection Cycle 269
8. Acquisition and Expenditure Cycle 328
9. The Production Cycle and Auditing
Inventory 389
10. Finance and Investment Cycle 443
11. Completing the Audit 499
Brief Contents
First Pages
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Chapter 2
Professional Standards 41
Introduction 42
Generally Accepted Auditing Standards (GAAS) 44
Organization of GAAS 45

67. Fundamental Principle: Responsibilities 46
Competence and Capabilities 47
Independence and Due Care 47
Professional Skepticism and Professional
Judgment 49
Fundamental Principle: Performance 50
Reasonable Assurance 51
Planning and Supervision 51
Materiality 52
Risk Assessment 53
Audit Evidence 54
Fundamental Principle: Reporting 56
Evaluating the Quality of Public Accounting Firms’
Practices 59
System of Quality Control 59
PCAOB Inspection of Firms 61
Summary 63
Key Terms 64
Multiple-Choice Questions for Practice and

68. Review 65
Exercises and Problems 69
Appendix 2A
Referencing Professional Standards 76
PART TWO
THE FINANCIAL STATEMENT AUDIT
Chapter 3
Engagement Planning and Audit Evidence
Introduction 79
Pre-Engagement Activities 80
Client Acceptance or Continuance 80
Compliance with Independence and Ethical
Requirements 83
Engagement Letters 84
Audit Plan 85
Staffing the Audit Engagement 86
Time Budget 89
Materiality 91
Materiality Calculation 92

69. PART ONE
THE CONTEMPORARY AUDITING
ENVIRONMENT
Chapter 1
Auditing and Assurance Services
User Demand for Reliable Information 2
Information Risk in a Big Data World 3
Auditing, Attestation, and Assurance Services 4
Definition of Financial Statement Auditing 5
Auditing in a Big Data Environment 6
Attestation Engagements 7
Assurance Services 8
Examples of Assurance Services 10
Management’s Financial Statement
Assertions 11
Existence or Occurrence (Existence, Occurrence,
Cutoff) 14
Completeness (Completeness, Cutoff) 14

70. Valuation and Allocation (Accuracy or
Valuation) 15
Rights and Obligations (Rights and
Obligations) 15
Presentation and Disclosure (Classification,
Understandability) 16
Importance of Assertions 16
Professional Skepticism 18
Public Accounting 21
Assurance Services 21
Tax Services 23
Advisory Services 23
Other Kinds of Engagements and Information
Professionals 24
Internal Auditing 24
Governmental Auditing 25
Regulatory Auditors 26

71. Become a Professional and Get Certified! 26
Education 27
Examination 27
Experience 28
State Certificate and License 29
Skill Sets and Your Education 30
Summary 31
Key Terms 31
Multiple-Choice Questions for Practice and
Review 32
Exercises and Problems 38
Contents
First Pages
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Audit Team Brainstorming Discussions 144
Inquiry of Audit Committee, Management, and Others

72. within the Company 144
Overall Assessment and Documentation of Inherent
Risk Assessment 145
Document Risk Assessment 146
Fraud and Other Significant Risks 146
Communication of Fraud Risks 147
Auditors’ Responsibilities for Client Noncompliance
with Laws and Regulations 148
Audit Strategy Memorandum 150
Summary 151
Key Terms 152
Multiple-Choice Questions for Practice and
Review 153
Exercises and Problems 157
Appendix 4A
Selected Financial Ratios 168
Appendix 4B
Sample Audit Memorandum 169
Chapter 5
Risk Assessment: Internal Control Evaluation
Introduction 173

73. Internal Control Defined 174
Management Versus Auditors’ Responsibility for
Internal Control 175
Management’s Internal Control Responsibilities 175
Auditors’ Internal Control Responsibilities 176
Components of Internal Control 178
Control Environment 179
Risk Assessment 181
Control Activities 182
Information and Communication 187
Monitoring 189
Limitations of Internal Control 190
Internal Control Evaluation 191
Phase 1: Understand and Document the Client’s Internal
Control 191
Phase 2: Assess the Control Risk (Preliminary) 197
Phase 3: Identify Controls to Test and Perform Tests of
Controls 199
Responsibilities in the Audits of Issuers Required by
PCAOB Auditing Standard No. 2201 204

74. Requirements 204
Internal Control Communications 207
Summary 209
Key Terms 209
Multiple-Choice Questions for Practice and Review 211
Exercises and Problems 214
Appendix 5A
Audit Plan 219
Audit Procedures for Obtaining Audit Evidence 94
1. Inspection of Records and Documents 96
2. Inspection of Tangible Assets 99
3. Observation 99
4. Inquiry 99
5. Confirmation 100
6. Recalculation 101
7. Reperformance 101
8. Analytical Procedures 101
Audit Documentation 103
Permanent Files 103
Current Files 104
Audit Documentation Arrangement and Indexing 105

75. Summary 107
Key Terms 108
Multiple-Choice Questions for Practice and
Review 109
Exercises and Problems 113
Chapter 4
The Audit Risk Model and Inherent Risk
Assessment
Introduction 118
Audit Risk 118
Audit Risk 118
Inherent Risk 119
Control Risk 120
Detection Risk 120
Audit Risk Model 120
Fraud Risk 124
Fraud 126
Types of Fraud 127
Inherent Risk Assessment—“What Could Go
Wrong?” 130

76. Understanding the Client’s Business and Its
Environment 132
Industry, Regulatory, and Other External
Factors 132
The Nature of the Company 133
Related Parties 134
Client Computerized Processing 134
Selection and Application of Accounting Principles,
Including Related Disclosures 135
Company Objectives, Strategies, and Related Business
Risks 136
Company Performance Measures 136
Gathering Information and Preliminary
Analytical Procedures 137
General Business Sources 137
Company Sources 138
Information from Client Acceptance or Continuance
Evaluation, Audit Planning, Past Audits, and Other

77. Engagements 138
Preliminary Analytical Procedures 138
First Pages
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Internal Control Activities and Design
Evaluation 281
Entity-Level Controls in the Revenue and Collections
Cycle 281
Control Considerations at the Account and Assertion
Level 282
Tests of Operating Effectiveness of Internal
Control 284
Summary: Control Risk Assessment 287

78. Substantive Analytical Procedures and Tests of
Details 288
Analytical Procedures 291
Confirmation of Accounts and Notes Receivable 291
Alternative Procedures 296
Additional Notes about Confirmations 297
Dual-Purpose Nature of Accounts Receivable
Confirmations 297
Review for Collectability 297
Cutoff and Sales Returns 298
Audit Risk Model Applied 300
Application in the Field 300
Audit Cases: Extended Audit Procedures 301
Summary 308
Key Terms 309
Multiple-Choice Questions for Practice and
Review 309
Exercises and Problems 314
Appendix 7A
Internal Control Questionnaires 324
Appendix 7B
Audit Plan 326

79. Chapter 8
Acquisition and Expenditure Cycle
Introduction 329
Acquisition and Expenditure Cycle: Typical
Activities 330
Purchasing Goods and Services 330
Receiving the Goods or Services 333
Recording the Asset or Expense and Related
Liability 333
Significant Accounts and Relevant
Assertions 333
Accounts Payable 334
Expenses 335
Risk of Material Misstatement 336
Internal Control Activities and Design
Evaluation 338
Entity-Level Controls 338
Control Considerations 338
Custody 340

80. Periodic Reconciliation 340
Chapter 6
Employee Fraud and the Audit of Cash
Introduction 221
Employee Fraud Overview 222
Employee Fraud Red Flags 223
Characteristics of Fraudsters 223
The Fraud Triangle 225
Incentive/Pressure 226
Opportunity 226
Attitude/Rationalization 227
Fraud Prevention 228
Managing People and Pressures in the Workplace 228
Internal Control Activities and Employee
Monitoring 229
Tone at the Top 231
The Audit of Cash 232
Management Reports and Data Files in an Audit of

81. Cash 233
Significant Accounts and Relevant Assertions 236
Risk of Material Misstatement 236
Evaluating the Design and Operating Effectiveness of
Internal Controls 237
Substantive Procedures 243
“Extended Procedures” to Detect Fraud 248
Summary 252
Key Terms 253
Multiple-Choice Questions for Practice and
Review 254
Exercises and Problems 258
Appendix 6A
Internal Control Questionnaires 266
Appendix 6B
Audit Plans 268
Chapter 7
Revenue and Collection Cycle
Introduction 270
Revenue and Collection Cycle: Typical
Activities 271

82. Receiving and Processing Customer Orders, Including
Credit Granting 272
Delivering Goods and Services to Customers 272
Billing Customers and Accounting for Accounts
Receivable 273
System Generated Reports and Data Files in the Revenue
and Collection Cycle 273
Significant Accounts and Relevant Assertions 276
Risk of Material Misstatement 277
Revenue Recognition 277
Collectability of Accounts Receivable 280
Customer Returns and Allowances 280
First Pages
xxx Contents
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83. Financing the Entity through Debt and Stockholder
Equity 447
Financial Planning 447
Raising Capital 447
Investing Transactions: Investments
and Intangibles 450
Significant Accounts and Relevant Assertions 452
Risk of Material Misstatement 453
Complex Transactions 454
Fair Market Value 455
Related-Party Transactions 455
Lease Accounting 456
Loan Covenants 456
Impairments 457
Presentation and Disclosure 457
Internal Control Activities and Design
Evaluation 458
Control Considerations 460
Tests of Operating Effectiveness of Internal
Control 460

84. Control over Accounting Estimates 463
Authorization 464
Record Keeping 464
Custody 465
Summary: Control Risk Assessment 465
Substantive Analytical Procedures and Tests of
Details 466
Auditing Accounting Estimates, including Fair Value
Measurements 472
Long-Term Liabilities and Related Accounts 475
Stockholders’ Equity: Substantive Procedures 476
Auditing Stock-Based Compensation Plans 477
Fraud Cases: Extended Audit Procedures 478
Summary 482
Key Terms 483
Multiple-Choice Questions for Practice and
Review 484
Exercises and Problems 487
Appendix 10A
Internal Control Questionnaires 495

85. Appendix 10B
Substantive Audit Plans 496
Chapter 11
Completing the Audit
Introduction 500
Audit Timeline 501
Procedures Performed During Fieldwork 503
Completing Substantive Procedures 503
Attorney Letters 504
Written Representations 507
Ability to Continue as a Going Concern 509
Adjusting Entries and Financial Statement
Disclosure 510
Testing of Operating Effectiveness of Internal
Control 341
Tests of Controls 341
Substantive Analytical Procedures and Tests of
Details 344
Open Purchase Orders 346

86. Audit Risk Model Applied 352
Fraud Cases: Extended Audit Procedures 354
Audit Issues in the Expense and Acquisition Cycle 357
Summary 358
Key Terms 358
Multiple-Choice Questions for Practice and
Review 359
Exercises and Problems 362
Appendix 8A
Internal Control Questionnaires 372
Appendix 8B
Audit Plans 375
Appendix 8C
The Payroll Cycle 377
Chapter 9
The Production Cycle and Auditing Inventory
Keeping Count 390
Inventory Management: Typical Activities 391
Significant Accounts and Relevant Assertions 395
Risk of Material Misstatement 396
Internal Control Activities and Design
Evaluation 399
Testing of Operating Effectiveness of Internal
Control 403

87. Substantive Analytical Procedures and Tests of
Details 408
Difficult Inventory Circumstances 415
Audit Risk Model Applied 420
Fraud Case: Extended Audit Procedures (AS 2301) 421
Summary 422
Key Terms 424
Multiple-Choice Questions for Practice and
Review 425
Exercises and Problems 428
Appendix 9A
Internal Control Questionnaires 439
Appendix 9B
Audit Plans 441
Chapter 10
Finance and Investment Cycle
Introduction 444
Finance and Investment Cycle: Typical
Activities 446

88. First Pages
Contents xxxi
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PART THREE
STAND-ALONE MODULES
MODULE A
Other Public Accounting Services
Introduction 594
Introduction to Attestation Engagements 595
Attestation Engagements: Special Audit Reporting
Considerations 596
Special Purpose Frameworks 597
Specified Elements, Accounts, or Items 598
Compliance with Contractual Agreements or Regulatory
Requirements 599
Other Attestation Engagements 600
Applying Agreed-Upon Procedures 600
Prospective Financial Information 601

89. Compliance Attestation 604
Service Organizations 606
Other Attestation Engagements and Summary 608
Accounting and Review Services for Historical
Financial Information 609
Review Engagements 609
Compilation Engagements 611
Preparation Engagements 612
Summary of Engagements on Historical Financial
Information 613
Assurance Services Engagements 614
Scope of Assurance Services 614
Trust Services 615
The Future of Assurance Services 617
Summary 617
Key Terms 618
Multiple-Choice Questions for Practice and
Review 619
Exercises and Problems 623

90. MODULE B
Professional Ethics
Introduction 632
General Ethics 633
An Ethical Decision Process 634
Philosophical Principles in Ethics 635
The Imperative Principle 635
The Principle of Utilitarianism 637
The Generalization Argument 637
Virtue Ethics 637
Ethical Codes of Conduct 638
U.S. Securities and Exchange Commission
(SEC) 639
The Public Company Accounting Oversight Board
(PCAOB) 639
The International Federation of Accountants
(IFAC) 640
Audit Documentation Review 513
Subsequent Events and Subsequently

91. Discovered Facts 514
Subsequent Events 515
Subsequently Discovered Facts 516
Responsibilities Following the Audit Report Release
Date 518
Omitted Procedures 518
Communications with Individuals Charged with
Governance 518
Management Letter 520
Summary of Audit Communications 520
Summary 521
Key Terms 521
Multiple-Choice Questions for Practice and
Review 522
Exercises, Problems, and Simulations 526
Chapter 12
Reports on Audited Financial
Statements
Introduction 538

92. Overview of Auditors’ Reports 539
The Standard Report for Non-Issuers 540
Types of Opinions 542
Conditions that Require Modifications to
the Auditors’ Standard (Unmodified)
Report 543
Departures from GAAP 543
Scope Limitations 546
Audits of Group Financial Statements 550
Auditors’ Reports Referencing Other Matters
Encountered During the Audit 553
Consistency 553
“Going-Concern” Uncertainties 554
Other Information Included in Annual
Reports 555
Required Supplementary Information 556
Other Modifications 556
Summary: Emphasis-of-Matter and Other-Matter

93. Paragraphs 557
Other Reporting Topics 557
Comparative Financial Statements 558
Summary Financial Statements 560
Supplementary Information 561
Disclaimers of Opinion 561
Summary 562
Key Terms 564
Multiple-Choice Questions for Practice and
Review 565
Exercises and Problems 568
Appendix 12A
Auditors’ Reports for Issuers (Public
Entities) 581
First Pages
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94. The Changing Landscape of Auditors’ Liability 698
Sarbanes–Oxley 699
Racketeer Influenced and Corrupt Organizations Act 700
Aiding and Abetting 700
Organization of Accounting Firms as Limited Liability
Partnerships 701
Proportionate Liability 701
Class-Action Suits 702
Auditors’ Liability Caps 703
Other Developments 703
Summary 704
Key Terms 705
Multiple-Choice Questions for Practice and Review 706
Exercises and Problems 711
MODULE D
Internal Audits, Governmental Audits,
and Fraud Examinations 721
Introduction 722
Internal Audits, Governmental Audits,
and Fraud Examinations 722
Internal Audits 723

95. Internal Auditing Defined 723
Types of Internal Audit Services 725
Internal Audit Standards 728
Internal Audit Reports 729
Governmental Audits 730
Governmental Auditing Defined 730
Types of Governmental Audits 731
GAO Government Auditing Standards 733
GAO Audit Reports 734
Single Audit Act of 1984 and Amendments of 1996 735
Fraud Examinations 737
The Art of Fraud Examinations 739
Fraud Examiner Responsibilities 741
Building a Fraud Case 742
Protecting the Evidence 742
Obtaining Litigation Support 742
Summary 743
Key Terms 744
Multiple-Choice Questions for Practice and
Review 745
Exercises and Problems 748

96. MODULE E
Attributes Sampling 757
Introduction 758
Planning (Steps 1-3) 759
Step 1: Determine the Objective of Sampling 759
Step 2: Define the Characteristic of Interest 759
Step 3: Define the Population 760
Performing (Steps 4-6) 761
Step 4: Determine the Sample Size 761
The Professional Ethics Executive Committee (PEEC) of
the American Institute of CPAs (AICPA) 640
An Emphasis on Independence 642
American Institute of Certified Public Accountants 642
SEC and PCAOB Independence Rules 649
Other Effects of Sarbanes–Oxley on Auditor
Independence 652
Government Accountability Office (GAO) Independence
Requirements 652
AICPA Rules of Conduct: Integrity and

97. Objectivity, Responsibilities to Clients, and Other
Responsibilities 653
Integrity and Objectivity Rule 653
General Standards Rule 654
Compliance with Standards Rule 655
Accounting Principles Rule 655
Confidential Client Information Rule 656
Fees and Other Types of Remuneration 658
Acts Discreditable Rule 660
Advertising and Other Forms of Solicitation Rule 660
Form of Organization and Name Rule 661
Consequences of Violating the Code of Professional
Conduct 662
Self-Regulatory Discipline 663
Public Regulation Discipline 664
Summary 665
Key Terms 666
Multiple-Choice Questions for Practice and
Review 666
Exercises and Problems 671

98. MODULE C
Legal Liability 679
The Legal Environment 681
Liability Under Common Law 683
Liability to Clients 683
Liability to Third Parties 684
Liability for Compilation and Review Services 688
Liability Under Statutory Law 689
The Securities Act of 1933 (Securities Act) 690
Section 11: Civil Liability 690
Auditors’ Defenses under the Securities Act 691
Section 13: Statute of Limitations 692
Section 17: Antifraud 692
Section 24: Criminal Liability 692
The Securities Exchange Act of 1934 (Securities
Exchange Act) 693
Section 10 and Rule 10(b)-5: Antifraud 693
Section 18: Civil Liability 694
Auditors’ Defenses under the Securities Exchange Act 695
Section 32: Criminal Liability 695

99. Foreign Corrupt Practices Act (FCPA) 696
Summary of Auditors’ Liability to Clients and Third
Parties 697
First Pages
Contents xxxiii
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Risk Assessment Procedures 850
Tests of Controls 852
Substantive Analytical Procedures 853
Tests of Details 855
Conducting Audit Data Analytics 857
Plan the ADA 857
Access and Prepare the Data 858
Consider the Relevance and Reliability of the Data
Used 859
Perform the ADA 861

100. Evaluate the Results and Draw Conclusions 861
Documentation Requirements 862
Common Tools Used in ADA 863
Professional Skepticism in ADA 864
The Next Generation of Auditing 864
External Big Data 865
Artificial Intelligence 865
Distributed Ledger Technology 865
Summary 866
Key Terms 867
Multiple-Choice Questions for Practice and
Review 868
Exercises and Problems 870
MODULE H
Information Technology Auditing 881
Information Technology (IT) Systems 882
Reliance on IT Controls 884
Scoping the IT Audit Procedures 885
Types of IT Control Activities 886

101. General IT Controls 887
Automated Application Controls 893
Output Controls 896
Assessing Control Risk in an IT Environment 898
Testing Controls in an IT Environment 900
End-User Computing and Other Environments 903
End-User Computing Control Considerations 903
Service Organizations 905
Computer Abuse and Computer Fraud 906
Preventive, Detective, and Damage-Limiting
Controls 907
Computer Forensics 909
Summary 909
Key Terms 910
Multiple-Choice Questions for Practice and
Review 911
Exercises and Problems 913
Index 922

102. Step 5: Select the Sample Items 767
Step 6: Measure the Sample Items 767
Evaluating Sample Results (Step 7) 768
Calculating the Upper Limit Rate of Deviation 768
Making the Evaluation Decision 770
Qualitative Evaluation of Deviations 771
Documenting 773
Other Attributes Sampling Methods 774
Summary 775
Key Terms 776
Multiple-Choice Questions for Practice and Review 777
Exercises and Problems 780
Appendix E.A
AICPA Sample Size Tables 793
Appendix E.B
AICPA Sample Evaluation Tables 795
MODULE F
Variables Sampling 796
Introduction 797
Role of Variables Sampling in the Audit 797
Definition of Variables Sampling 797

103. Monetary Unit Sampling (MUS): Planning 798
Steps 1–3: Planning 799
MUS: Performing 800
Step 4: Determine the Sample Size 800
Step 5: Select the Sample Items 804
Step 6: Measure the Sample Items 805
MUS: Evaluating 806
Step 7: Evaluating Sample Results 806
Other Variables Sampling Approaches 811
Documentation in Variables Sampling 812
Summary 813
Key Terms 813
Multiple-Choice Questions for Practice and Review 815
Exercises and Problems 818
Appendix F.A
AICPA MUS Tables 829
Appendix F.B
Classical Variables Sampling 831
Appendix F.C
Nonstatistical Sampling 842

104. MODULE G
Data and Analytics in Auditing 845
Introduction 846
Audit of the Future 848
Data and Analytics 849
Common Uses of Audit Data Analytics 850
Auditing &
Assurance Services
First Pages
1
lou6920x_ch01_001-040.indd 1 02/19/20 02:57 PM
LEARNING OBJECTIVES
You are about to embark on a journey of
understanding how auditors work to keep the capital

105. markets safe and secure for the investing public. You
should know that students demonstrate success in
the auditing course quite differently from the way
they do in other accounting courses. For example,
when taking financial accounting, students typically
demonstrate success by correctly identifying the
proper journal entry for a given set of facts and
circumstances. In auditing, success is typically
demonstrated by completing multiple-choice, short-
answer, and simulation-type questions based on the
professional standards that regulate the auditing
process. Overall, this book provides you with a
comprehensive set of materials that will allow you
to master these professional auditing standards.
Chapter 1 provides an introduction to the auditing
and assurance profession.
Your objectives are to be able to
LO 1-1 Define information risk and explain how the
financial statement auditing process helps to
reduce this risk, thereby reducing the cost of
capital for a company.

106. LO 1-2 Define and contrast financial statement
auditing, attestation, and assurance services.
LO 1-3 Describe and define the assertions that
management makes about the recognition,
measurement, presentation, and disclosure
of the financial statements and explain why
auditors use them as the focal point of the
audit.
Doty, James R. Keynote Address: The Reliability, Role and
Relevance of the Audit:
A Turning Point. New York: Public Company Accounting
Oversight Board, 2011.
Our system of capital formation relies upon the confidence of
millions of
savers to invest in companies. The auditor’s opinion is critical
to that trust.
Auditing and
Assurance Services
C H A P T E R 1

107. Professional Standards References
Topic
AU-C/ISA
Section
AS
Section
Overall Objectives of the Independent Auditor 200
1001 1005
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

108. First Pages
2 Part One The Contemporary Auditing Environment
lou6920x_ch01_001-040.indd 2 02/19/20 02:57 PM
USER DEMAND FOR RELIABLE INFORMATION
When seeking capital to grow their business, management has
an incentive to present
their company’s financial statements and future prospects in a
manner that will entice
potential investors and creditors. As a result, it is essential that
investors and creditors have
assurance that they can rely on the information provided by
management, which creates
demand for the financial statement audit. If only investors in
Theranos, a blood-testing
startup company, had asked for an independent audit report. In
March 2018, the Securi-
ties and Exchange Commission (SEC) settled massive fraud
charges against Theranos and
their president, Sunny Balwani. The SEC’s complaint alleged
that the materials provided
to potential investors included a company overview, reports of
clinical trials, and financial

109. statement information and projections. However, the package
did not include an indepen-
dent audit report. Unfortunately the company, which was valued
as high as $9 billion by
investors back in 2009, barely had enough cash to pay the bills
just five years later.1 This
example helps to reinforce why it is so important for investors
and creditors to review
audited financial statements as they consider whether to invest
or loan money to a com-
pany. It also helps to explain why audit quality is so important
to investors and creditors.
You may be asking, why is audit quality so important? Well, as
we have just seen,
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.
To help ensure that audit quality is not compromised, the
Sarbanes–Oxley Act of 2002
created the Public Company Accounting Oversight Board
(PCAOB) to regulate the

110. audit profession for public companies. In fact, the PCAOB is
responsible for setting all
audit standards to be followed on audits of public companies. In
addition, the PCAOB is
required to perform inspections of the audit work completed and
the quality control pro-
cesses employed by audit firms. As a direct result, accounting
students should know that
if they plan to work as financial statement auditors, they will be
entering a world that is
focused on audit quality. Consider the following Auditing
Insight.
LO 1-1
Define information risk and
explain how the financial
statement auditing process
helps to reduce this risk,
thereby reducing the cost of
capital for a company.
1https://www.marketwatch.com/story/the-investors-duped-by-
the-theranos-fraud-never-asked-for-one-important-
thing-2018-03-19

111. In January 2019, KPMG published its report on audit quality for
2018. In the report, the firm’s leaders affirmed their
responsibility
to the investing public for instilling confidence in the capital
mar-
kets. The key drivers of the firm’s audit quality efforts include
a
strong system of quality control, including the establishment of
a
firm culture with an unrelenting focus on delivering high
quality
audits. In addition, and perhaps most importantly, the report
high-
lighted the importance of developing its people and its
investment
in the audit of the future. The report specifically discussed the
firm’s investment in cognitive technologies such as IBM’s Wat-
son and the importance of harnessing the emerging power of
Big Data. The report is a clear indication to students that
quality
matters more than anything else in their future work as auditing
professionals.
Source:

112. https://home.kpmg/content/dam/kpmg/us/pdf/2019/01/progress-
through-change-kpmg-2018-audit-quality-report.pdf?n=3.
Audit QualityAUDITING INSIGHT
LO 1-4 Define professional skepticism and explain
its key characteristics.
LO 1-5 Describe the organization of public
accounting firms and identify the various
services that they offer.
LO 1-6 Describe the audits and auditors in
governmental, internal, and operational
auditing.
LO 1-7 List and explain the requirements for
becoming a certified public accountant
(CPA) and other certifications available to an
accounting professional.
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113. Chapter 1 Auditing and Assurance Services 3
lou6920x_ch01_001-040.indd 3 02/19/20 02:57 PM
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, under-
standable, and timely information. When you have a better
understanding of why audit-
ing 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 profession and the capital markets.
Information Risk in a Big Data World
All businesses make a countless number of decisions each and
every day. Decisions to

114. purchase or sell goods or services, lend money, enter into
employment agreements, or
buy or sell investments depend in large part on the quality of
useful information. These
decisions affect business risk, which is the risk that an entity
will fail to meet its objec-
tives. For example, business risk includes the chance a
company takes that customers will
buy from competitors, that product lines will become obsolete,
that taxes will increase,
that government contracts will be lost, or that employees will go
on strike. If the company
fails to meet its objectives enough times, the company may
ultimately fail. To minimize
these risks and take advantage of other opportunities presented
in today’s competitive
business environment, decision makers such as chief executive
officers (CEOs) demand
timely, relevant, and reliable information. Similarly, investors
and creditors demand high-
quality information to make educated financial decisions.
Information professionals such
as accountants and auditors help satisfy this demand.
In recent years, as a result of ever-increasing computing power,

115. the decision-making
environment is rapidly being transformed into one that is
characterized by the availability
of significant amounts of data and information. Let’s face it, the
amount of informa-
tion that organizations are seeking to manage is larger than
anyone could have possibly
imagined just 10 years ago. You are entering a world where
upper management teams are
placing more emphasis than ever on how to make sense of this
seemingly ever-increasing
availability of data and information. To help you prepare for
this “big data” challenge, we
will be drawing upon this theme in multiple chapters throughout
this book.
There are at least four environmental conditions in this big data
world that increase
user demand for relevant and reliable information:
1. Complexity. Events and transactions in today’s global
business environment are numer-
ous and often very complicated. You may have studied
derivative securities and hedging
activities in other accounting courses, but investors and other

116. decision makers may not
have your level of expertise when dealing with these complex
transactions. Furthermore,
these decision makers are not trained to collect, compile, and
summarize the key operat-
ing information themselves. They need the services provided by
information profession-
als to help make the information more understandable for their
decision processes.
2. Remoteness. Decision makers are usually separated from
current and potential business
partners not only by a lack of expertise but also by distance and
time. Investors may not
be able to visit distant locations to check up on their
investments. They need to employ
full-time information professionals to do the work they cannot
do for themselves.
3. Time sensitivity. Today’s economic environment requires
businesses, investors, and
other financial information users to make decisions more
rapidly than ever before. The
ability to promptly obtain high-quality information is essential
to businesses that want

117. to remain competitive in our global business environment.
4. Consequences. Decisions can involve a significant
investment of resources. The con-
sequences are so important that reliable information, obtained
and verified by infor-
mation professionals, is an absolute necessity. Enron’s
aftermath provides a graphic
example of how decisions affect individuals’ (as well as
companies’) financial secu-
rity and well-being. Enron’s stock dropped from $90 to $0.90 in
little more than a
year, leaving employees who had invested their life savings in
the company virtually
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4 Part One The Contemporary Auditing Environment
lou6920x_ch01_001-040.indd 4 02/19/20 02:57 PM
penniless. To put this drop in perspective, an investor’s $5
million investment in Enron

118. stock in 2000 (enough for an enjoyable retirement) was worth
only $50,000 a year later.
A further complication in effective decision making is the
presence of information risk.
Information risk is the probability that the information
circulated by a company will be
false or misleading. Decision makers usually obtain their
information from companies or
organizations they want to conduct business with, provide loans
to, or engage with in buy-
ing or selling the company’s stock. Because the primary source
of information is the target
company itself, an incentive exists for that company’s
management to make its business
or service appear to be better than it actually is, to put its best
foot forward. As a result,
preparers and issuers of financial information (directors,
managers, accountants, and other
people employed in a business) might benefit by giving false,
misleading, or overly opti-
mistic information. This potential conflict of interest between
information providers and
users, along with financial statement frauds such as those of
Enron and WorldCom, leads

119. to a natural skepticism on the part of users. Thus, they depend
on information profession-
als to serve as independent and objective intermediaries who
will lend credibility to the
information. This lending of credibility to information is known
as providing assurance.
When the assurance is provided for specific assertions made by
management, we refer to
the assurance provided as attestation. When the assertions are
embodied in a company’s
financial statements, we refer to the attestation as auditing.
More specifically, when their
work is completed, the auditors supply an opinion as to whether
the financial statements
and related footnotes are presented fairly in all material
respects. The actual compilation
and creation of the financial statements is completed by the
company’s accountants.
Bernard Madoff, a former chairman of the NASDAQ stock
market and
a respected Wall Street adviser and broker for 50 years, was
arrested
after his sons turned him in for running “a giant Ponzi scheme,”
bilking

120. investors out of billions of dollars. Many investors, including
actors,
investment bankers, politicians, and sports personalities, lost
their
life savings. Some who had already retired, now in their 70s and
80s,
were forced to go back to work. Others lost their retirement
homes.
Charities and pensions that had invested heavily were wiped
out.
Although some of the world’s most knowledgeable investors fell
prey to the scam, numerous red flags were present for all who
were
wise enough to see them. First, Madoff’s fund returned 13–16
percent
per year, every year, no matter how the markets performed.
Second,
his stated strategy of buying stocks and related options to hedge
downside risk could not have occurred because the number of
options
necessary for such a strategy did not exist. Third, although his
firm
claimed to manage billions of dollars, its auditing firm had only

121. three
employees, including a secretary and a 78-year-old accountant
who
lived in Florida.
Sources: “Fund Fraud Hits Big Names,” The Wall Street
Journal, December
13, 2008, pp. A1, A7; “Fees, Even Returns and Auditor All
Raised Flags,”
The Wall Street Journal, December 13, 2008, p. A7; “Top
Broker Accused
of $50 Billion Fraud,” The Wall Street Journal, December 12,
2008, pp. A1,
A14; “Probe Eyes Audit Files, Role of Aide to Madoff,” The
Wall Street Journal,
December 23, 2008, pp. A1, A14.
The Consequences of Fraudulent Financial
Information
AUDITING INSIGHT
REVIEW CHECKPOINTS
1.1 What is a business risk?
1.2 What conditions increase the demand for reliable

122. information?
1.3 What risk creates a demand for independent and objective
outsiders to provide assurance to
decision makers?
AUDITING, ATTESTATION, AND ASSURANCE SERVICES
Now that you understand why decision makers need independent
information profession-
als to provide assurance on key information, we further define
auditing and expand the
discussion of attestation and assurance services in this section,
and explain their roles in
today’s information economy.
LO 1-2
Define and contrast financial
statement auditing, attestation,
and assurance services.
First Pages
Chapter 1 Auditing and Assurance Services 5