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![xxviii About the Authors
Larry E. Rittenberg
Larry E. Rittenberg, Ph.D., CPA, CIA, is Professor Emeritus, Department
of Accounting and Information Systems, at the University of Wisconsin–
Madison, where he taught courses in auditing, risk management, and cor-
porate governance. He is also Chair Emeritus of the COSO of the Treadway
Commission, where he provided oversight of the development of the COSO
Enterprise Risk Management Framework, the COSO Guidance for Smaller
Businesses, and was instrumental in developing the Framework for COSO
2013. He has served as Vice-Chair of Professional Practices for the Institute
of Internal Auditors (IIA) and President of the IIA Research Foundation, and
has been a member of the Auditing Standards Committee of the AAA Audit-
ing Section, the NACD Blue Ribbon Commission on Audit Committees, the
IIA’s Professional Practices Committee, and Vice-President and Treasurer of
the AAA. He recently retired as audit committee chair and board member of
Woodward Governor, a publicly traded company, and has consulted on audit
committee, risk, and control issues with Petro China – the largest public
company in China. Professor Rittenberg served as a staff auditor for Ernst
Young and has co-authored five books and monographs and numerous
research articles.
Recommendations from Instructors Who Have
Used OurTextbook Previously
Professor Tim Bell, University of North Florida. I have used [this] text for
seven years now and it has been an outstanding resource for teaching my
students the fundamentals of contemporary auditing. Text discussions and
end-of-chapter applications help me to develop students’ critical analysis and
judgment skills, sensitivity and responses to ethical dilemmas, and under-
standing and appreciation of the essential role of professional skepticism in
auditing…. My impression based on use of successive editions of the text is
that the authors have worked very hard to ensure it is up-to-date as auditing
standards and related guidance evolve and audit-relevant events occur in the
rapidly-changing business environment. Without reservation, I highly recom-
mend this text.
Professor Veena L. Brown, University of Wisconsin-Milwaukee. This text-
book is ideal for my students as it presents a good mix of theory and practice
using the integrated audit approach. The authors do a great job portraying
the auditing concepts in a deceptively simple manner. The Exhibits and the
Professional Judgment in Context presented in each chapter helps students
better grasp the sometimes-elusive auditing concepts. I have successfully used
this textbook for the past six years and look forward to exploring the next
edition with my students.
Professor Barry J. Bryan, Southern Methodist University. I selected this text-
book because I believe that it presents a realistic approach to the integrated
audit. Having worked with several of the Big Four firms, it is evident to me
that the authors have been diligent in writing a book that mirrors the risk-
based approach to the audit. In addition, my students have enjoyed outstand-
ing success on the AUD Exam having used this text as their primary study
resource.
Professor Sean Dennis, University of Kentucky. I use this book because it has
it all… detailed (yet intuitive!) explanations, challenging review questions for
students, and detailed cases that are both timely and relevant.The authors have
organized the material in a way that helps students build an understanding of
risk and the audit process from the ground up. The questions and cases at the
end of the chapters also help create engaging discussions among students that
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- 4. A Risk-based Approach AUDITING 1 1 TH E D I T I O N A Risk-based Approach AUDITING JOHNSTONE | GRAMLING | RITTENBERG 1 1 T H E D I T I O N SE / Johnstone/Gramling/Rittenberg / Auditing: A Risk-Based Approach, 11e ISBN-13: 9781337619455 ©2019 Designer: Stratton Design Printer: Xxxxx Binding: Casebound Trim: 8.5” x 10.875” CMYK JOHNSTONE GRAMLING RITTENBERG A Risk-based Approach AUDITING JOHNSTONE | GRAMLING | RITTENBERG 1 1 T H E D I T I O N To register or access your online learning solution or purchase materials for your course, visit www.cengagebrain.com.
- 5. Auditing Standards PCAOB Standards GeneralAuditing Standards 1000 General Principles and Responsibilities • AS 1001: Responsibilities and Functions of the Independent Auditor • AS 1005: Independence • AS 1010: Training and Proficiency of the Independent Auditor • AS 1015: Due Professional Care in the Performance of Work 1100 General Concepts • AS 1101: Audit Risk • AS 1105: Audit Evidence • AS 1110: Relationship of Auditing Standards to Quality Control Standards 1200 General Activities • AS 1201: Supervision of the Audit Engagement • AS 1205: Part of the Audit Performed by Other Independent Auditors • AS 1210: Using the Work of a Specialist • AS 1215: Audit Documentation • AS 1220: Engagement Quality Review 1300 Auditor Communications • AS 1301: Communications with Audit Committees • AS 1305: Communications About Control Deficiencies in an Audit of Financial Statements Audit Procedures 2100 Audit Planning and Risk Assessment • AS 2101: Audit Planning • AS 2105: Consideration of Materiality in Planning and Performing an Audit • AS 2110: Identifying and Assessing Risks of Material Misstatement 2200 Auditing Internal Control Over Financial Reporting • AS 2201: An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements 2300 Audit Procedures in Response to Risks—Nature, Timing, and Extent • AS 2301: The Auditor’s Responses to the Risks of Material Misstatement • AS 2305: Substantive Analytical Procedures • AS 2310: The Confirmation Process • AS 2315: Audit Sampling 2400 Audit Procedures for Specific Aspects of the Audit • AS 2401: Consideration of Fraud in a Financial Statement Audit • AS 2405: Illegal Acts by Clients • AS 2410: Related Parties • AS 2415: Consideration of an Entity’s Ability to Continue as a Going Concern 2500 Audit Procedures for Certain Accounts or Disclosures • AS 2501: Auditing Accounting Estimates • AS 2502: Auditing Fair Value Measurements and Disclosures • AS 2503: Auditing Derivative Instruments, Hedging Activities, and Investments in Securities • AS 2505: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments • AS 2510: Auditing Inventories 19455_end2-4.indd 2 1/4/18 6:43 PM
- 6. 2600 Special Topics •AS 2601: Consideration of an Entity’s Use of a Service Organization • AS 2605: Consideration of the Internal Audit Function • AS 2610: Initial Audits—Communications Between Predecessor and Successor Auditors 2700 Auditor’s Responsibilities Regarding Supplemental and Other Information • AS 2701: Auditing Supplemental Information Accompanying Audited Financial Statements • AS 2705: Required Supplementary Information • AS 2710: Other Information in Documents Containing Audited Financial Statements 2800 Concluding Audit Procedures • AS 2801: Subsequent Events • AS 2805: Management Representations • AS 2810: Evaluating Audit Results • AS 2815: The Meaning of “Present Fairly in Conformity with Generally Accepted Accounting Principles” • AS 2820: Evaluating Consistency of Financial Statements 2900 Post-Audit Matters • AS 2901: Consideration of Omitted Procedures After the Report Date • AS 2905: Subsequent Discovery of Facts Existing at the Date of the Auditor’s Report Auditor Reporting 3100 Reporting on Audits of Financial Statements • AS 3101: Reports on Audited Financial Statements • AS 3110: Dating of the Independent Auditor’s Report 3300 Other Reporting Topics • AS 3305: Special Reports • AS 3310: Special Reports on Regulated Companies • AS 3315: Reporting on Condensed Financial Statements and Selected Financial Data • AS 3320: Association with Financial Statements Matters Relating to Filings Under Federal Securities Laws • AS 4101: Responsibilities Regarding Filings Under Federal Securities Statutes • AS 4105: Reviews of Interim Financial Information Other Matters Associated with Audits • AS 6101: Letters for Underwriters and Certain Other Requesting Parties • AS 6105: Reports on the Application of Accounting Principles • AS 6110: Compliance Auditing Considerations in Audits of Recipients of Governmental Financial Assistance • AS 6115: Reporting on Whether a Previously Reported Material Weakness Continues to Exist IAASB Standards • ISA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Inter- national Standards on Auditing • ISA 210 Agreeing the Terms of Audit Engagements • ISA 220 Quality Control for an Audit of Financial Statements • ISA 230 Audit Documentation • ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements • ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements • ISA 260 Communication with Those Charged with Governance • ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management • ISA 300 Planning an Audit of Financial Statements • ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment 19455_end2-4.indd 3 1/4/18 6:43 PM
- 7. • ISA 320Materiality in Planning and Performing an Audit • ISA 330 The Auditor’s Responses to Assessed Risks • ISA 402 Audit Considerations Relating to an Entity Using a Service Organization • ISA 450 Evaluation of Misstatements Identified during the Audit • ISA 500 Audit Evidence • ISA 501 Audit Evidence-Specific Considerations for Selected Items • ISA 505 External Confirmations • ISA 510 Initial Audit Engagements-Opening Balances • ISA 520 Analytical Procedures • ISA 530 Audit Sampling • ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures • ISA 550 Related Parties • ISA 560 Subsequent Events • ISA 570 Going Concern • ISA 580 Written Representations • ISA 600 Special Considerations-Audits of Group Financial Statements (Including the Work of Component Auditors) • ISA 610 Using the Work of Internal Auditors • ISA 620 Using the Work of an Auditor’s Expert • ISA 700 Forming an Opinion and Reporting on Financial Statements • ISA 705 Modifications to the Opinion in the Independent Auditor’s Report • ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report • ISA 710 Comparative Information-Corresponding Figures and Comparative Financial Statements • ISA 720 The Auditor’s Responsibilities Relating to Other Information in Documents Containing Audited Financial Statements • ISA 800 Special Considerations-Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks • ISA 805 Special Considerations-Audits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial Statement • ISA 810 Engagements to Report on Summary Financial Statements • International Standard on Quality Control (ISQC) 1, Quality Controls for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements AICPA Standards Section Title Preface Principles Underlying an Audit Conducted in Accordance with Generally Accepted Auditing Standards 200–299 General Principles and Responsibilities • 120 Defining Professional Requirements in Statements on Auditing Standards • 150 Generally Accepted Auditing Standards • 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Generally Accepted Auditing Standards • 201 Nature of the General Standards • 210 Training and Proficiency of the Independent Auditor • 220 Independence • 230 Due Professional Care in the Performance of Work • 210 Terms of Engagement • 315 Communications Between Predecessor and Successor Auditors • 220 Quality Control for an Engagement Conducted in Accordance with Generally Accepted Auditing Standards • 230 Audit Documentation • 240 Consideration of Fraud in a Financial Statement Audit • 250 Consideration of Laws and Regulations in an Audit of Financial Statements • 260 The Auditor’s Communication with Those Charged with Governance • 265 Communicating Internal Control Related Matters Identified in an Audit 300–499 Risk Assessment and Response to Assessed Risks • 300 Planning an Audit • 315 Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement (Continued on back cover endsheets) 19455_end2-4.indd 4 1/4/18 6:43 PM
- 8. Australia • Brazil• Mexico • Singapore • United Kingdom • United States A RISK-BASED APPROACH AUDITING JOHNSTONE | GRAMLING | RITTENBERG 1 1 T H E D I T I O N 19455_fm_hr_i-xxxi.indd 1 1/24/18 3:36 PM
- 9. Cengage is aleading provider of customized learning solutions with employees residing in nearly 40 different countries and sales in more than 125 countries around the world. Find your local representative at www.cengage.com. Cengage products are represented in Canada by Nelson Education, Ltd. To learn more about Cengage platforms and services, visit www.cengage.com To register or access your online learning solution or purchase materials for your course, visit www.cengagebrain.com Auditing: A Risk-Based Approach, 11e Karla M. Johnstone, Audrey A. Gramling and Larry E. Rittenberg Senior Vice President: Erin Joyner Product Director: Jason Fremder Product Manager: Matt Filimonov Content Developer: Emily Lehmann Product Assistant: Aiyana Moore Digital Content Specialist: Timothy Ross Manufacturing Planner: Doug Wilke Project Management and Composition: SPi Global Sr. Art Director: Michelle Kunkler Text Designer: Ke Design/Trish Knapke Cover Designer: Stratton Design Intellectual Property Analyst: Reba Frederics Project Manager: Kelli Besse Cover Image: cozyta/Shutterstock.com, Orhan Cam/Shutterstock.com, islavicek/ Shutterstock.com, Gardeazabal/ Shutterstock.com © 2019, 2016 Cengage Learning, Inc. Unless otherwise noted, all content is © Cengage ALL RIGHTS RESERVED. No part of this work covered by the copyright herein may be reproduced or distributed in any form or by any means, except as permitted by U.S. copyright law, without the prior written permission of the copyright owner. For product information and technology assistance, contact us at Cengage Customer Sales Support, 1-800-354-9706 For permission to use material from this text or product, submit all requests online at www.cengage.com/permissions Further permissions questions can be emailed to [email protected] Library of Congress Control Number: 2017960519 ISBN: 978-1-337-61945-5 Cengage 20 Channel Center Street Boston, MA 02210 USA Printed in the United States of America Print Number: 01 Print Year: 2018 19455_fm_hr_i-xxxi.indd 2 1/24/18 3:36 PM
- 10. iii Brief Contents Preface. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxvii 1 Quality Auditing: Why It Matters. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2 The Auditor’s Responsibilities Regarding Fraud and Mechanisms to Address Fraud: Regulation and Corporate Governance. . . . . . . . . . . . . . . 56 3 Internal Control Over Financial Reporting: Responsibilities of Management and the External Auditor . . . . . . . . . . . . . . . . . . . . . . . . . 98 4 Professional Legal Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 5 Professional Auditing Standards and the Audit Opinion Formulation Process . . . . . . . . 170 6 Audit Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222 7 Planning the Audit: Identifying, Assessing, and Responding to the Risk of Material Misstatement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278 8 Specialized Audit Tools: Attributes Sampling, Monetary Unit Sampling, and Data Analytics Tools. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 338 9 Auditing the Revenue Cycle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400 10 Auditing Cash, Marketable Securities, and Complex Financial Instruments . . . . . . . . . . 490 11 Auditing Inventory, Goods and Services, and Accounts Payable: The Acquisition and Payment Cycle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 568 12 Auditing Long-Lived Assets and Merger and Acquisition Activity. . . . . . . . . . . . . . . . . . . 642 13 Auditing Debt, Equity, and Long-Term Liabilities Requiring Management Estimates. . . 700 14 Completing a Quality Audit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 734 15 Audit Reports for Financial Statement Audits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 794 ACL Appendix. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 853 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 869 Case Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 871 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 873 “Why It Matters” Feature Content . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 886 Auditing Standards. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 889 Additional Resources. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 895 19455_fm_hr_i-xxxi.indd 3 1/24/18 3:36 PM
- 11.
- 12. v Contents PREFACE xiii ABOUT THEAUTHORS xxvii How Can You Learn by Leveraging The Features of this Textbook? xxix 1Quality Auditing: Why It Matters 2 An Overview of External Auditing 4 Decision Makers’Need for Reliable Information and the Role of a Financial Statement Audit 4 What Is a Financial Statement Audit? 6 Parties Involved in Preparing and Auditing Financial Statements 9 Providers of External Auditing Services 9 Skills and Knowledge Needed by External Auditors 10 Achieving Audit Quality 11 Audit Firm Culture 12 Skills and Qualities of the Engagement Team 13 Effectiveness of the Audit Process 13 Reliability and Usefulness of Audit Reporting 13 Factors Outside the Control of Auditors 14 Professional Conduct Requirements that Help Auditors Achieve Audit Quality 15 AICPA Requirements: Code of Professional Conduct 16 SEC and PCAOB: Other Guidance on Professional Responsibilities 25 International Professional Requirements That Help Auditors Achieve Audit Quality 27 Frameworks for Professional and Ethical Decision Making 28 A Framework for Professional Decision Making 28 A Framework for Ethical Decision Making 32 Importance of Client Acceptance and Continuance Decisions to Audit Quality 35 Risks Considered in Client Acceptance and Continuance Decisions 37 Other Considerations 39 Engagement Letters 39 Significant Terms 41 Prompt for Critical Thinking 44 Review Questions and Short Cases 44 Fraud Focus: Contemporary and Historical Cases 49 Application Activities 54 Academic Research Cases 55 2The Auditor’s Responsibilities Regarding Fraud and Mechanisms to Address Fraud: Regulation and Corporate Governance 56 Fraud Defined 58 Misappropriation of Assets 58 Fraudulent Financial Reporting 58 The Fraud Triangle 60 Incentives or Pressures to Commit Fraud 62 Opportunities to Commit Fraud 62 Rationalizing the Fraud 63 History of Fraudulent Financial Reporting 64 Examples of Recent Frauds and Implications for External Auditors 64 Insights from COSO Studies 64 The Enron Fraud 67 Fraud: Auditors’Responsibilities and Users’ Expectations 72 Fraud-Related Requirements in Professional Auditing Standards 72 The Sarbanes-Oxley Act of 2002 as a Regulatory Response to Fraud 74 Corporate Governance Defined 77 Characteristics of Effective Corporate Governance 80 Responsibilities of Audit Committees 81 Significant Terms 84 Prompt for Critical Thinking 85 Review Questions and Short Cases 86 Fraud Focus: Contemporary and Historical Cases 91 Application Activities 95 Academic Research Cases 97 19455_fm_hr_i-xxxi.indd 5 1/24/18 3:36 PM
- 13. vi Contents 3Internal ControlOver Financial Reporting: Responsibilities of Management and the External Auditor 98 Importance of Internal Control Over Financial Reporting 100 Internal Control Defined 101 Entity-Wide Controls and Transaction Controls 103 Control Environment 105 Commitment to Integrity and Ethical Values (COSO Principle 1) 106 The Board of Directors Exercises Oversight Responsibility (COSO Principle 2) 106 Management Establishes Structure, Authority, and Responsibility (COSO Principle 3) 107 The Organization Demonstrates Commitment to Competence (COSO Principle 4) 107 The Organization Enforces Accountability (COSO Principle 5) 108 Risk Assessment 109 Management Specifies Relevant Objectives (COSO Principle 6) 109 The Organization Identifies and Analyzes Risk (COSO Principle 7) 110 The Organization Assesses Fraud Risk (COSO Principle 8) 110 The Organization Identifies and Analyzes Significant Change (COSO Principle 9) 110 Control Activities 111 The Organization Selects and Develops Control Activities (COSO Principle 10) 112 Management Selects and Develops General Controls Over Technology (COSO Principle 11) 115 The Organization Deploys Control Activities Through Policies and Procedures (COSO Principle 12) 116 Information and Communication 117 The Organization Uses Relevant Information (COSO Principle 13) 117 The Organization Communicates Internally (COSO Principle 14) 118 The Organization Communicates Externally (COSO Principle 15) 118 Monitoring 120 The Organization Conducts Ongoing and/or Separate Evaluations (COSO Principle 16) 120 Management Evaluates and Communicates Deficiencies (COSO Principle 17) 121 Management’s Responsibilities for Internal Control Over Financial Reporting 122 Management Documentation of Internal Control 122 Management Reporting on Internal Control Over Financial Reporting 123 Evaluating Internal Control Over Financial Reporting 125 Assessing Deficiencies in Internal Control Over Financial Reporting 127 Importance of Internal Control to the External Audit 131 Application: Assessing Control Design Effectiveness, Implementation, and Operating Effectiveness 131 Significant Terms 135 Prompt for Critical Thinking 137 Review Questions and Short Cases 137 Fraud Focus: Contemporary and Historical Cases 144 Application Activities 145 Academic Research Cases 147 4Professional Legal Liability 148 The Legal Environment and the Effects of Lawsuits on Audit Firms 150 Liability Doctrines 150 Class Action Lawsuits 151 Contingent-Fee Compensation for Lawyers 151 The Audit Viewed as an Insurance Policy: The Expectations Gap 152 Applicable Laws and Causes of Legal Action 153 Types of Law and Legal Actions Relevant to Auditors 153 Parties that May Bring Suit Against Auditors 154 Auditor Liability under Contract Law, Common Law, and Statutory Law 156 Contract Law: Liability to Clients 156 Common Law: Liability to Third Parties 157 Statutory Law: Liability to Third Parties 158 Significant Terms 162 Review Questions and Short Cases 163 Fraud Focus: Contemporary and Historical Cases 167 Application Activities 168 Academic Research Case 169 5Professional Auditing Standards and the Audit Opinion Formulation Process 170 Professional Auditing Standards 172 Auditing Standards Issued by the AICPA, IAASB, and PCAOB 173 Comparing the Auditing Standards 174 Principles Underlying the Auditing Standards 175 PCAOB Guidance—Five Topical Categories of Standards 175 19455_fm_hr_i-xxxi.indd 6 1/24/18 3:36 PM
- 14. Contents vii AICPA Guidance:Principles Governing an Audit 176 IAASB Guidance: Objectives of an Audit 176 OverviewoftheAuditOpinion FormulationProcess 177 Audit Opinion Formulation Process: Accounting Cycles 179 Audit Opinion Formulation Process: Financial Statement Assertions 180 Existence or Occurrence Assertion 181 Completeness Assertion 181 Rights and Obligations Assertion 182 Valuation or Allocation Assertion 183 Presentation and Disclosure Assertion 184 Audit Opinion Formulation Process: Audit Evidence and Audit Procedures 184 Evidence Example: Substantive Audit Procedures to Obtain Evidence About Management’s Valuation Assertion 185 Audit Opinion Formulation Process: Audit Documentation 186 Five Phases of the Audit Opinion Formulation Process 187 Phase I—Making Client Acceptance and Continuance Decisions 187 Phase II—Performing Risk Assessment 189 Phase III—Obtaining Evidence About Internal Control 194 Phase IV—Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions 202 Phase V—Completing the Audit and Making Reporting Decisions 205 Applying Decision-Making Frameworks 207 Significant Terms 208 Prompt for Critical Thinking 209 Review Questions and Short Cases 210 Fraud Focus: Contemporary and Historical Cases 217 Application Activities 219 Academic Research Cases 221 6Audit Evidence 222 Obtaining Sufficient Appropriate Audit Evidence 224 Sufficiency of Audit Evidence 226 Appropriateness of Audit Evidence 228 Audit Procedures 234 Types of Audit Procedures 234 Timing of Procedures 240 Substantive Analytical Procedures 241 Performing Analytical Procedures 243 Brief Application of Substantive Analytical Procedures 246 Additional Evidence Considerations 247 Auditing Management Estimates 247 Auditing Related-Party Transactions 249 Using a Specialist/Expert to Assist with Obtaining Audit Evidence 251 Documenting Audit Evidence 253 Documenting Risk Assessment Procedures 253 Documenting Tests of Controls and Substantive Procedures 254 Documenting Significant Findings and Their Resolution 255 Characteristics of Quality Audit Documentation 255 Audit Programs 257 Applying Decision-Making Frameworks 259 Significant Terms 260 Prompt for Critical Thinking 262 Review Questions and Short Cases 262 Fraud Focus: Contemporary and Historical Cases 268 Application Activities 272 Academic Research Cases 275 Data Analytics Using ACL 276 7Planning the Audit: Identifying, Assessing, and Responding to the Risk of Material Misstatement 278 Materiality 280 Materiality Levels 281 Planning Materiality 282 Identifying and Assessing the Risk of Material Misstatement 286 Client Business Risks 286 The Audit Risk Model 291 Responding to Identified Risk of Material Misstatement 303 Determining Evidence Needed in the Audit 303 Audit Procedures to Respond to the Assessed Risk of Material Misstatement 306 Applying Decision-Making Frameworks 309 Significant Terms 310 Prompt for Critical Thinking 311 Review Questions and Short Cases 314 Fraud Focus: Contemporary and Historical Cases 322 Application Activities 334 Academic Research Cases 337 19455_fm_hr_i-xxxi.indd 7 1/24/18 3:36 PM
- 15. viii Contents 8Specialized AuditTools: AttributesSampling, Monetary Unit Sampling, and Data AnalyticsTools 338 Using Sampling and Data Analytics Tools for Gathering and Evaluating Audit Evidence 341 Objectives of Sampling and Risks Associated with Sampling 343 Nonsampling and Sampling Risks 343 Nonstatistical and Statistical Sampling 346 Attributes Sampling for Tests of Controls 349 Steps in Attributes Sampling 349 Basic Steps in Sampling Account Balances and Assertions: A Nonstatisical Sampling Application 362 Basic Steps in Sampling Account Balances and Assertions 362 Nonstatistical Sampling for Substantive Tests of Account Balances and Assertions 365 Statistical Sampling for Substantive Tests of Account Balances and Assertions: Monetary Unit Sampling (MUS) 367 Summary of MUS Strengths and Weaknesses 367 Designing and Selecting a MUS Sample 368 Evaluating a MUS Sample 372 Using Data Analytics Tools to Obtain and Evaluate Evidence 377 Defining Data Analytics and Associated Terms 377 Using Data Analytics Tools in the Audit 381 Business Intelligence Platforms 383 Applying Decision-Making Frameworks 385 Significant Terms 386 Prompt for Critical Thinking 390 Review Questions and Short Cases 391 Application Activities 398 Data Analytics: Spreadsheet Modelling and Database Querying 399 Academic Research Cases 399 9Auditing the Revenue Cycle 400 Significant Accounts, Disclosures, and Relevant Assertions 402 Processing Revenue Transactions 404 An Overview of the Audit Opinion Formulation Process in the Revenue Cycle 406 Identifying Inherent Risks 407 Inherent Risks: Revenue 407 Inherent Risks: Accounts Receivable 410 Identifying Fraud Risks 411 How do Fraudsters Perpetrate their Schemes? 411 Identifying Fraud Risk Factors 413 Identifying Control Risks 418 Controls Related to Existence/Occurrence 419 Controls Related to Completeness 421 Controls Related to Valuation 421 Documenting Controls 423 Performing Planning Analytical Procedures 425 Responding to Identified Risks of Material Misstatement 428 Obtaining Evidence About Internal Control Operating Effectiveness in the Revenue Cycle 430 Selecting Controls to Test and Performing Tests of Controls 432 Considering the Results of Tests of Controls 434 Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions in the Revenue Cycle 435 Revenue and Accounts Receivable: Performing Substantive Analytical Procedures 437 Revenue: Substantive Tests of Details 438 Accounts Receivable: Substantive Procedures 439 Accounts Receivable: Substantive Tests of Details—Confirmations 439 Accounts Receivable: Substantive Procedures for the Allowance Account 447 Accounts Receivable: Other Substantive Procedures 448 Performing Substantive Fraud-Related Procedures 449 Documenting Substantive Procedures 452 Applying Decision-Making Frameworks 454 Significant Terms 454 Prompt for Critical Thinking 455 Review Questions and Short Cases 457 Fraud Focus: Contemporary and Historical Cases 470 Application Activities 480 Data Analytics Using Excel: A Case in the Context of the Pharmaceutical Industry 485 Data Analytics Using ACL 487 Data Analytics Using Tableau 488 Academic Research Cases 489 10 Auditing Cash, Marketable Securities, and Complex Financial Instruments 490 Significant Accounts, Disclosures, and Relevant Assertions 493 19455_fm_hr_i-xxxi.indd 8 1/24/18 3:36 PM
- 16. Contents ix Common CashAccounts: Checking, Cash Management, and Petty Cash Accounts 493 Relevant Financial Statement Assertions 494 An Overview of the Audit Opinion Formulation Process for Cash Accounts 497 Identifying Inherent Risks 498 Identifying Fraud Risks 499 Identifying Control Risks 501 Typical Controls Over Cash 502 Implications of Ineffective Controls 505 Controls for Petty Cash 507 Controls for Cash Management Techniques 507 Documenting Controls 507 Performing Planning Analytical Procedures 510 Responding to Identified Risks of Material Misstatement 512 Obtaining Evidence about Internal Control Operating Effectiveness for Cash 514 Selecting Controls to Test and Performing Tests of Controls 514 Considering the Results of Tests of Controls 515 Obtaining Substantive Evidence about Cash Accounts, Disclosures, and Assertions 516 Cash Accounts: Performing Substantive Analytical Procedures 518 Cash Accounts: Performing Substantive Tests of Details 518 Performing Substantive Fraud-Related Procedures for Cash Accounts 524 Documenting Substantive Procedures 525 Auditing Marketable Securities 526 Significant Accounts, Disclosures, and Relevant Assertions 526 An Overview of the Audit Opinion Formulation Process for Marketable Securities 528 Identifying Inherent, Fraud, and Control Risks Relevant to Marketable Securities 528 Performing Planning Analytical Procedures for Marketable Securities 531 Responding to Identified Risks of Material Misstatement 531 Obtaining Evidence about Internal Control Operating Effectiveness for Marketable Securities 532 Obtaining Substantive Evidence about Marketable Securities 532 Auditing Complex Financial Instruments 536 Overview of Complex Financial Instruments 536 Audit Considerations for Complex Financial Instruments 536 Applying Decision-Making Frameworks 540 Significant Terms 541 Prompts for Critical Thinking 542 Review Questions and Short Cases 545 Fraud Focus: Contemporary and Historical Cases 556 Application Activities 563 Data Analytics: Spreadsheet Modelling and Database Querying 567 11 Auditing Inventory, Goods and Services, and Accounts Payable:The Acquisition and Payment Cycle 568 Significant Accounts, Disclosures, and Relevant Assertions 571 Processing Transactions in the Acquisition and Payment Cycle 572 Assertions Relevant to Inventory 573 Assertions Relevant to Accounts Payable 574 An Overview of the Audit Opinion Formulation Process in the Acquisition and Payment Cycle 575 Identifying Inherent Risks 575 Identifying Fraud Risks 577 Identifying Control Risks 578 Overview of Internal Controls in the Acquisition and Payment Cycle 579 Documenting Controls 586 Performing Planning Analytical Procedures 588 Responding to Identified Risks of Material Misstatement 592 Obtaining Evidence About Internal Control Operating Effectiveness in the Acquisition and Payment Cycle 594 Selecting Controls to Test and Performing Tests of Controls 594 Considering the Results of Tests of Controls 595 Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions in the Acquisition and Payment Cycle 598 Substantive Tests of Inventory and Cost of Goods Sold 598 Substantive Tests of Accounts Payable and Related Expense Accounts 611 Documenting Substantive Procedures 616 Applying Decision-Making Frameworks 618 Significant Terms 619 Prompt for Critical Thinking 620 Review Questions and Short Cases 621 Fraud Focus: Contemporary and Historical Cases 630 Application Activities 634 19455_fm_hr_i-xxxi.indd 9 1/24/18 3:36 PM
- 17. x Contents Data AnalyticsUsing Excel: A Case in the Context of the Pharmaceutical Industry 637 Academic Research Cases 640 ACL 640 12 Auditing Long-Lived Assets and Merger and Acquisition Activity 642 Significant Accounts, Disclosures, and Relevant Assertions 645 Activities in the Long-Lived Asset Acquisition and Payment Cycle 645 Relevant Financial Statement Assertions 646 An Overview of the Audit Opinion Formulation Process in the Revenue Cycle 646 Identifying Inherent Risks 647 Identifying Fraud Risks 649 Identifying Control Risks 650 Internal Controls for Long-lived Assets 652 Documenting Controls 653 Performing Planning Analytical Procedures 654 Responding to Identified Risks of Material Misstatement 656 Obtaining Evidence About Internal Control Operating Effectiveness for Long-Lived Asset Accounts and Related Expenses 660 Selecting Controls to Test and Performing Tests of Controls 660 Considering the Results of Tests of Controls 661 Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions for Long-Lived Asset Accounts and Related Expenses 663 Performing Substantive Analytical Procedures 664 Substantive Tests of Details for Tangible Assets 666 Substantive Tests of Details for Natural Resources and the Related Expense Accounts 668 Substantive Tests of Details for Intangible Assets and the Related Expense Accounts 669 Substantive Procedures Related to Asset Impairment 669 Substantive Procedures Related to Leases 672 Performing Substantive Fraud-Related Procedures 673 Documenting Substantive Procedures 674 Auditing Merger and Acquisition Activities 674 Valuing the Assets and Liabilities of an Acquisition 675 Audit Considerations for Valuing Identifiable Assets and Liabilities 676 Audit Considerations for Restructuring Charges Related to an Acquisition 678 Audit Considerations for Valuing Goodwill 679 Applying Decision-Making Frameworks 681 Significant Terms 682 Prompt for Critical Thinking 683 Review Questions and Short Cases 684 Fraud Focus: Contemporary and Historical Cases 690 Academic Research Cases 699 13 Auditing Debt, Equity, and Long-Term Liabilities Requiring Management Estimates 700 Significant Accounts, Disclosures, and Relevant Assertions 702 Debt 702 Equity 703 An Overview of the Audit Opinion Formulation Process for Debt and Equity 705 Identifying Inherent Risks 705 Inherent Risks—Debt 705 Inherent Risks—Equity 705 Identifying Fraud Risks 707 Identifying Control Risks 709 Controls—Debt 709 Controls—Equity 709 Documenting Controls 710 Performing Planning Analytical Procedures 710 Responding to Identified Risks of Material Misstatement 711 Obtaining Evidence about Internal Control Operating Effectiveness for Debt and Equity 712 Selecting Controls to Test and Performing Tests of Controls 712 Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions for Debt and Equity 713 Substantive Analytical Procedures—Debt 713 Substantive Tests of Details—Debt 715 Substantive Tests of Details—Equity 716 Performing Substantive Fraud-Related Procedures for Debt and Equity 717 Documenting Substantive Procedures 718 Long-Term Liabilities Requiring Management Estimates 719 Warranty Reserves 719 Pension Obligations and Other Postemployment Benefits 721 Applying Decision-Making Frameworks 723 Significant Terms 724 19455_fm_hr_i-xxxi.indd 10 1/24/18 3:36 PM
- 18. Contents xi Prompt forCritical Thinking 724 Review Questions and Short Cases 725 Fraud Focus: Contemporary and Historical Cases 729 Application Activities 730 Data Analytics Using Excel: A Case in the Context of the Pharmaceutical Industry 731 Academic Research Case 733 14 Completing a Quality Audit 734 Obtain Remaining Audit Evidence 737 Detected Misstatements 737 Loss Contingencies 742 Adequacy of Disclosures 747 Noncompliance with Laws and Regulations 752 Review Analytical Procedures 755 The Going-Concern Assumption 757 Subsequent Events 763 Management Representation Letter versus a Management Letter 767 Management Representation Letter 767 Management Letter 769 Engagement Quality Review 771 Audit Committee Communications 773 Significant Terms 777 Prompt for Critical Thinking 778 Review Questions and Short Cases 780 Fraud Focus: Contemporary and Historical Cases 785 Application Activities 789 Using ACL to Perform Benford Analysis 792 Academic Research Cases 793 15 Audit Reports for Financial Statement Audits 794 Audit Reporting Principles 796 Unqualified/Unmodified Audit Reports on Financial Statements 798 Unqualified Audit Reports: U.S. Public Companies 799 Unmodified Audit Reports: U.S. Nonpublic Companies 801 Unmodified Audit Reports: Non-U.S. Companies 802 Unqualified/Unmodified Audit Opinions with Report Modifications 804 Emphasis-of-Matter 804 Information about Certain Audit Participants 805 Reference to Other Auditors 806 Inconsistent Application of GAAP 808 Justified Departure from GAAP 809 Substantial Doubt about the Client Being a Going Concern 810 Client Correction of a Material Misstatement in Previously Issued Financial Statements 814 Qualified Opinions, Adverse Opinions, and Disclaimers of Opinion 816 Qualified Opinions 816 Adverse Opinions 820 Disclaimers of Opinion 821 Critical Audit Matters and Key Audit Matters 824 Key Audit Matters (KAMs) 824 Critical Audit Matters (CAMs) 826 KAMs or CAMs? 829 Audit Reports on Internal Control Over Financial Reporting for U.S. Public Companies 830 Omitted Audit Procedures 834 Applying Decision-Making Frameworks 836 Significant Terms 837 Prompt for Critical Thinking 838 Review Questions and Short Cases 840 Fraud Focus: Contemporary and Historical Cases 847 Application Activities 850 Academic Research Cases 851 ACL APPENDIX 853 REFERENCES 869 CASE INDEX 871 INDEX 873 “WHY IT MATTERS”FEATURE CONTENT 886 AUDITING STANDARDS 889 ADDITIONAL RESOURCES 895 19455_fm_hr_i-xxxi.indd 11 1/24/18 3:36 PM
- 19.
- 20. xiii The auditing environmentcontinues to change in significant ways. University graduates entering the auditing profession today should be prepared for a high standard of responsibility, should be ready to serve the public interest, and should recognize the emerging issues and continuing points of focus facing auditors. Examples of today’s emerging issues and continuing points of focus facing the profession include: • New accounting guidance from the Financial Accounting Standards Board on leases and revenue recognition. • Increased need for critical thinking and professional skepticism. • Increased and growing use of data analytics tools. • Continued and increasing importance of ethical and professional deci- sion making. • Continued efforts toward international convergence of auditing stan- dards of the American Institute of Certified Public Accountants (AICPA) and the International Auditing and Assurance Standards Board (IAASB). • Reorganization of the Public Company Accounting Oversight Board (PCAOB) auditing standards to provide auditors and others with a logi- cal framework and easy access to the standards governing the conduct of audits of public companies. • The IAASB’s issuance of new and revised auditor reporting standards, which require auditors to provide more transparent and informative reports on the companies they audit, including the disclosure of key audit matters. • The PCAOB’s adoption of a new auditing standard on the auditor’s report, including the disclosure of critical audit matters. The eleventh edition of Financial Statement Auditing: A Risk-Based Approach represents the most up-to-date professional auditing guidance avail- able and reflects the many emerging issues and continuing points of focus in the profession. This text provides students with the tools they need to under- stand the full range of issues associated with conducting a quality financial statement audit in an evolving national and global context. Revision Themes and New Enhancements in the Eleventh Edition Coverage of Emerging Data Analytics Tools. Data analytics tools include qual- itative and quantitative techniques and processes that auditors use to enhance their productivity and effectiveness in terms of extracting, categorizing, iden- tifying, and analyzing patterns in their client’s data. Emerging data analytics tools facilitate testing 100% of a population, enabling the auditor to focus on potentially erroneous transactions or risky areas of the audit. These emerging tools also include sophisticated data visualization tools, for example, Tableau. Data analytics tools also include familiar platforms such as Excel, ACL, and IDEA; the landscape is changing dramatically and quickly in this space, so instructors and students must be adaptive to fast-paced change. We introduce Preface 19455_fm_hr_i-xxxi.indd 13 1/24/18 3:36 PM
- 21. xiv Preface key termsand explain data analytics tools in an expanded Chapter 8, with an entirely new section, “Using Data Analytics Tools to Obtain and Evaluate Evidence.” We also include end-of-chapter problems to reinforce opportuni- ties to employ data analytics tools within Chapter 8 and the following cycle chapters (e.g., data analytics in the revenue cycle in Chapter 9). Auditing Standards Exhibit–PCAOB, AICPA, and IAASB–appears inside the front cover of this textbook. This exhibit allows for easy access to relevant standards, and provides a platform for relative comparisons across each of the standards-setting bodies. End-of-chapter problems require students to review and apply the material in the Auditing Standards Exhibit. These problems provide students with practice completing task-based simulations similar to what they will see on the CPA exam; we highlight these problems with an identifying icon. Three New Learning Engagement Features. Students today demand more than case facts and standard lectures. They require opportunities to engage with the instructor and classmates on important topics facing the profession. • “Why It Matters” feature. This feature helps students see beyond the factual insights provided in the chapters. Elements include for example, extensions based on in-the-news examples that illustrate fundamen- tal features and applications of text facts, professional standards in foreign jurisdictions, and interesting points that may be tangential to the text facts, but that should facilitate students’ deep engagement with the chapter. Certain of these features are noted as relating to an International Focus. • “Prompt for Critical Thinking—It’s Your Turn!” feature. This feature encourages students to engage in critical thinking as they acquire knowl- edge relevant to each chapter. This feature is intentionally creative in form and substance, and varies widely in structure based upon the learn- ing objective to which it is related. As an example of one such prompt, students are asked to consider auditors’ responsibilities with respect to internal controls around the Foreign Corrupt Practices Act. • “What Do You Think?—For Classroom Discussion” feature. This fea- ture provides an avenue by which instructors can facilitate preparation for class, cognitive engagement, and critical thinking through discus- sions with other students. Like the Prompt for Critical Thinking fea- ture, What Do You Think? is creative in form and substance and varies in unexpected ways to spark students’ interest in engagement with the chapter topic. This feature is an ideal way for instructors to facilitate an interesting class discussion using a flipped-classroom approach (either involving the entire class or within small teams). Below we provide examples of each of these three new learning engagement features that appear in Chapter 14 (“Completing a Quality Audit”) with respect to the learning objective “Obtaining Remaining Audit Evidence on Noncompliance with Laws and Regulations.” • The Why It Matters feature articulates the motivation for and provisions of the Foreign Corrupt Practices Act (FCPA). • The Prompt for Critical Thinking feature extends this discussion by prompting students to think about corruption, how to measure it, and its variation across different jurisdictions. • The What Do You Think? feature encourages students to consider the applicability of the FCPA in today’s business and auditing environment. 19455_fm_hr_i-xxxi.indd 14 1/24/18 3:36 PM
- 22. Preface xv Compliance withthe Foreign Corrupt Practices Act (FCPA) of 1977 This feature highlights an important law that many companies have failed to comply with. The FCPA was written to respond to SEC investigations in the 1970s revealing that over 400 companies had made questionable or ille- gal payments of over $300 million to foreign officials, politicians, and political parties.The payments involved bribery of foreign offi- cials to facilitate business operations in their respective foreign countries. The main provisions of the FCPA include: • No U.S. person or company that has securities listed on U.S. markets may make a payment to a foreign official for the purpose of obtaining or retaining business. This provision is commonly called the anti-bribery provision of the FCPA. • Companies that have securities listed on U.S. markets must make and keep financial records that accurately and fairly reflect the transactions of the company and must design and maintain an adequate system of internal accounting controls. • Certain payments to foreign officials are acceptable. These include grease payments, which are payments made to an official to expedite the performance of the duties that the official would already be bound to perform. Why It Matters Before reading this text, had you heard of the Transparency Inter- national corruption perception index?Think critically about what you know about the political and economic structure of the fol- lowing countries. In the spaces below, (1) rank the six countries from most corrupt to least corrupt just from what you know, and (2) guess what their ranking is on a scale from 02100 on the cor- ruption perception index from 0 (highly corrupt) to 100 (very clean): Prompt for Critical Thinking Country (in alphabetical order) Rank 5 5 (1 most to 6 least corrupt among this list) Estimated corruption perception index 2 (0 100) Belgium Brazil New Zealand Somalia South Korea United States of America After ranking the countries, visit Transparency International and compare your answers and estimates against theirs: https://www.transparency.org/news/feature/corruption_perceptions_index_2016#table What are your reactions to what you have learned? What rankings surprised you? How accurate were your rankings? 19455_fm_hr_i-xxxi.indd 15 1/24/18 3:36 PM
- 23. xvi Preface Updates to“Focus on Fraud” Feature. The authors continue their use of this learning engagement feature, which provides compelling examples of recent frauds, and the role of the auditor in preventing, detecting, or (sometimes) not detecting those frauds. Below we provide an example of this learning feature that appears in Chapter 14 (“Completing a Quality Audit”) with respect to the learning objective “Obtaining Remaining Audit Evidence on Noncompliance with Laws and Regulations.” For Classroom Discussion The FCPA of 1977 was enacted a LONG time ago! 1. Do you think it is still relevant today? Why or why not? 2. Review the following SEC website: https://www.sec.gov/spotlight/fcpa/fcpa-cases.shtml What are your impressions? What surprises you? What companies on this list are well-known? Focus on one of the enforcement actions (perhaps at the discretion of your instructor) and explain how the company violated the FCPA. What Do You Think? Triton Energy and Noncompliance with Laws and Regulations Thisfeaturedescribesahistoricallyimportantcaseinvolvingnoncom- pliance with the Foreign Corrupt Practices Act (FCPA) of 1977. Triton Energy engages in the exploration and production of crude oil and natural gas in many areas around the world. Triton has tra- ditionally operated in relatively high-risk, politically unstable areas where larger and better-known producers do not operate. Top Triton Indonesia officials (President, CFO, Commercial Manager, and Controller) were investigated by the SEC for violations of the Foreign Corrupt Practices Act. These violations included: • Improper payments were made to a middleman who used the funds to reduce Triton Indonesia’s tax liability. • Improper payments were made to a middleman who used the funds to ensure a favorable governmental audit. • Improper payments were made to a middleman who used the funds to obtain corporate tax refunds from government officials. • The recording of false journal entries by Triton Indonesia’s Commercial Manager and Controller were made to cover up the improper payments. These improper payments and false journal entries were facilitated because Triton’s CEO, Bill Lee, was an aggressive top manager who provided weak tone at the top in terms of his failure to encourage compliance with applicable laws and regulations, failure to discourage improper payments, and failure to imple- ment internal controls to deter improper payments. Triton was ultimately fined $300,000 related to the scandal. For further details, see the SEC’s Securities Exchange Act of 1934 ReleaseNo.38343andAccountingandAuditingEnforcementRelease No. 889, February 27, 1997. Focus on Fraud • To help students prepare for the CPA exam, MindTap for Auditing includes two pre- and post-tests using author-selected multiple-choice questions from Becker Professional Education, all tailored to this edi- tion’s critical learning objectives. • “Check Your Basic Knowledge” feature. To enhance and expand on the Becker CPA Exam Questions feature, each chapter includes additional true-false and multiple-choice questions within the chapter text itself. 19455_fm_hr_i-xxxi.indd 16 1/24/18 3:36 PM
- 24. Preface xvii Following thediscussion of each learning objective within the chapters, we challenge students to answer four questions (two true-false and two multiple-choice) to alert students to their effective learning, or alterna- tively, to their lack of understanding (which should encourage students to more carefully acquire the concepts relating to each particular learn- ing objective). Taken collectively, the Becker CPA Exam Questions and Check Your Basic Knowledge questions ensure that students have the opportunity to challenge themselves during reading the chapter, thereby tracking their learning, and after reading the chapter. • Updated and Expanded Chapter Examples and End-of-Chapter prob- lems, including “Review Questions and Short Cases,” “Application Activities,” along with more extensive longer cases: “Fraud Focus: Contemporary and Historical Cases.” To help instructors identify these problems, the text includes the following icons that highlight overall themes: Ethics, Fraud, Professional Skepticism, International Issues, and Auditing Standards Application Activities. We also rely exten- sively on using facts from SEC Accounting, Auditing, and Enforcement Releases (AAERs) and PCAOB Enforcement Actions in the cases to illus- trate the regulatory implications of auditors’ judgments and decisions. For most chapters, we have updated the Academic Research Cases, providing instructors with an opportunity to introduce students to the relevance of academic research to the auditing profession. Examples of Selected Cases by Chapter include: Longtop Financial Technologies (Ch. 1), Bentley’s Brisbane Partnership (Ch. 1), Wells Fargo (Ch. 2), Weatherford International (Ch. 2), Lime Energy (Ch. 2), U.S. Department of Defense (Ch. 3), Diamond Foods (Ch. 3), Chesapeake Petroleum and Supply (Ch. 3), Florida Department of Financial Services (Ch. 4), Toshiba (Ch. 4), Boeing (Ch. 5), ContinuityXSolutions, Inc. (Ch. 7), Ag Feed Industries (Ch. 9), China Media Express Holdings (Ch. 9), Monsanto Corpora- tion (Ch. 9), Agricultural Bank of China (Ch. 10), MagnaChip (Ch. 11), Miller Energy Resources (Ch. 12), Soyo Group (Ch. 13), Logitech (Ch. 13), 2GO (Ch. 14), Chelsea Logistics Holding Corp. (Ch. 14), Suiss Finance (Ch. 14), ImmunoGen, Inc. (Ch. 15), Rolls Royce (Ch. 15), and Westmoreland Coal Company (Ch. 15). Expanded View of “Users.” In prior versions, our user-emphasis was on shareholders, bondholders, regulators, and standards-setters as primary actors. While of course critical, we now incorporate discussion of the role that analysts play (e.g., in incentivizing managers, and therefore affecting the judgments and decisions of users), along with stock market reactions to both financial accounting and auditing information disclosures. As an illustration of one such view, we include the following discussion in Chapter 9 (the revenue cycle), embedded in a Why It Matters feature. 19455_fm_hr_i-xxxi.indd 17 1/24/18 3:36 PM
- 25. xviii Preface The Incentivefor Managers to Commit Fraud in the Revenue Cycle: The Role of Stock Analysts and Consensus Earnings Calculations This feature provides insight into the role that stock analyst following and consensus analyst earnings per share calculations play in affect- ing managements’ incentives to commit fraud. Stock analysts follow companies and issue earnings per share and revenue forecasts they anticipate for the companies they follow. To understand this concept better, see the analysts’forecast report for Ford Motor Company as of June 2017, which we reproduce below. Why It Matters This report shows that 16 analysts together, that is, by consensus predict Q1 2017 earnings per share of $0.35 per share, and that the actual results were better than that at $0.39 per share. It also shows that the annual earnings per share for 2016 was $1.76; analysts make predictions about both quarterly and annual earnings per share. Managers do not want to“disappoint”the market by having their earnings results come in “under forecast,” which creates the incentive for earnings manipulation. 19455_fm_hr_i-xxxi.indd 18 1/24/18 3:36 PM
- 26. Preface xix Hallmark PedagogicalFeatures Articulating an audit opinion formulation process to help organize students’ acquisition of the technical material in each chapter. A chapter-opening figure helps students identify the major phases in the audit process and see how the steps within that process relate to specific chapters. The textbook describes how auditors go through a structured judgment process to issue an audit opinion. We refer to this process as the Audit Opinion Formulation Process, and it serves as the foundation for this textbook. The process consists of five phases. Phase I concerns client acceptance and continuance. Once a client is accepted (or the audit firm decides to continue to provide services to a client), the auditor needs to perform risk assessment procedures to thoroughly understand the client’s business (or update prior knowledge in the case of a continuing client), its industry, its competition, and its management and governance processes (including internal controls) to determine the likelihood that financial accounts might be materially misstated (Phase II). In some audits, the auditor also obtains evidence about internal con- trol operating effectiveness through testing those controls (Phase III). Much of what most people think of as auditing, obtaining substantive evidence about accounts, disclosures, and assertions, occurs in Phase IV. The information gath- ered in Phases I through III greatly influences the amount of testing auditors perform in Phase IV. Finally, in Phase V, the auditor completes the audit and makes a decision about what type of audit report to issue. Also fundamental to students’ understanding is the framework’s inclusion of the auditing profession, audit quality, quality judgments, ethical decisions, and professional liability. Further fundamentals highlighted in the Audit Opin- ion Formulation Process include discussion of a framework for obtaining audit evidence, as depicted below. Recognizing that professional judgment, sufficient appropriate evidence, and quality decisions are critical to conducting a quality financial state- ment audit. In addition to the focus on professional judgment throughout the text, numerous exercises emphasize this key auditing skill, including examples and end-of-chapter materials based on the business press, PCAOB enforce- ment actions, SEC filings, and company proxy statements. Further, the end- of- chapter materials help ensure that students understand the link between mandatory financial reporting and auditing, risk assessment, transaction cycles, and analytical procedures. This report shows that 15 analysts together, that is, by consen- sus predict Q1 2017 revenues at $34.59 billion, while the actual revenue that Ford reported exceeded that estimate, coming in at $36.48 billion. Managers do not want to “disappoint” the market by having their revenue results come in “under forecast,” which creates the incentive for fraudulently overstated revenue amounts. What does the term “analyst consensus forecast” mean? It means the average earnings per share or revenue based on all the analysts that are following the company. If a company is at or near its consensus forecast and the auditor proposes a material, income decreasing audit adjustment, client management may resist because they do not want to report a negative earnings surprise. Whatisanegativeearningssurpriseoranegativerevenue surprise? It is a negative departure from the consensus analyst earnings forecast or the revenue forecast, for example, lower actual earn- ings per share amount compared to the consensus or lower rev- enue compared to the consensus expectation. For further details, see https://markets.ft.com/data/equities/tearsheet/forecasts?s=F:NYQ 19455_fm_hr_i-xxxi.indd 19 1/24/18 3:36 PM
- 27. xx Preface Emphasizing thatprofessional skepticism, which can be challenging to maintain, is at the heart of auditor judgments. This emphasis provides students with the tools to learn how to apply the concept of professional skepticism. We include conceptual discussion of this topic in Chapter 1, with substantial reinforcement through the remaining chapters in the text, as well as in end-of-chapter materials (highlighted with an identifying icon for ease of identification). This emphasis helps students see the practical application of professional skepticism, as well as provides practical insights as to downside risks when auditors fail to maintain appropriate levels of skepticism. Using data analytics tools and analytical procedures to improve the effec- tiveness and efficiency of the audit. The text contains a new focus on data analytics around“big data”that will become an evolving hallmark pedagogical feature over subsequent editions. The text covers planning, substantive, and review-related analytical procedures, and provides ways in which auditors can use data analytics tools to perform these procedures. Chapter 6 and Chapter 7 outline the theory of analytical procedures, and discuss appropriate processes and best practices. Various end-of-chapter problems provide examples of using analytical procedures. Chapters 9, 11, and 13 contain an extensive practice case (set in the pharmaceutical industry, complete with data based on three real companies) that would be ideal for a semester team project to enforce concepts around analytical procedures. Employing specific learning objectives, which we introduce at the outset of each chapter in a “What You Will Learn” feature and summarize at the end of each Chapter with a “Let’s Review” feature. We reinforce these objectives throughout the chapter materials, along with linking the objectives to specific end-of-chapter materials, including links to academic research cases to enhance students’ appreciation for the theoretical underpinnings of the learning objec- tives. These learning objectives help to shape students’ cognitive architecture as they integrate their preliminary understanding of chapter topics with the theory, examples, and accompanying discussion that follow. Providing and applying professional decision-making and ethical decision-making frameworks. Decision-making frameworks, introduced in Chapter 1, require students to think about real-life professional and ethical decisions associated in each chapter. End-of-chapter materials continue the use of these professional and ethical decision-making frameworks to help students Chapters 14 and 15 IV. Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions Chapters 8–13 III. Obtaining Evidence About Internal Control Operating Effectiveness Chapters 8–13 II. Performing Risk Assessment Chapters 2, 3, 7, and 9–13 I. Making Client Acceptance and Continuance Decisions Chapter 1 Professional Liability Chapter 4 The Audit Opinion Formulation Process and a Framework for Obtaining Audit Evidence Chapters 5 and 6 V. Completing the Audit and Making Reporting Decisions Auditing Profession, Audit Quality and the Need for Quality Judgments and Ethical Decisions Chapters 1 19455_fm_hr_i-xxxi.indd 20 1/24/18 3:36 PM
- 28. Preface xxi address contemporaryissues. Further, we identify these problems as part of the last learning objective in each chapter. Acquiring hands-on experience through a practice-oriented audit case. On the CengageNOW website, you will find a tool that allows students to engage in a practice-oriented audit case. Brony’s Bikes is an auditing case that encompasses a complete auditing scenario spanning from Performing Risk Assessment (Phase II of the Audit Opinion Formulation Process) to making reporting decisions (Phase V of the Audit Opinion Formulation Process). The case includes 13 modules that address specific activities included in the Audit Opinion Formulation Process. The authors have structured these 13 mod- ules so that each can be undertaken independently of the other modules. For example, Module I, Assessment of Inherent Risk, takes the students through the audit planning process based on AU-C 200 Overall Objectives of the Inde- pendent Auditor and the Conduct of an Audit in Accordance with Generally Accepted Auditing Standards, AU-C 300 Planning an Audit, and AU 315-C Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement. Module I can be assigned on a stand-alone basis or along with any or all of the other modules at the instructor’s discretion. Students gain experience with auditing documentation including many working papers. Analytical procedures are performed in Excel worksheets requiring conclusions and recommendations. Other Resources MindTap: EmpowerYour Students MindTap is a platform that propels students from memorization to mastery. It gives you complete control of your course, so you can provide engaging con- tent, challenge every learner, and build student confidence. Customize interac- tive syllabi to emphasize priority topics, then add your own material or notes to the eBook as desired. This outcomes-driven application gives you the tools needed to empower students and boost both understanding and performance. Access EverythingYou Need in One Place Cut down on prep with the preloaded and organized MindTap course materi- als. Teach more efficiently with interactive multimedia, assignments, quizzes, and more. Give your students the power to read, listen, and study on their phones, so they can learn on their terms. Empower Students to Reach their Potential Twelve distinct metrics give you actionable insights into student engagement. Identify topics troubling your entire class and instantly communicate with those struggling. Students can track their scores to stay motivated toward their goals. Together, you can be unstoppable. ControlYour Course—andYour Content Get the flexibility to reorder textbook chapters, add your own notes, and embed a variety of content including Open Educational Resources (OER). Personalize course content to your students’ needs. Students can even read your notes, add their own notes, and highlight key text to aid their learning. Get a DedicatedTeam, WheneverYou NeedThem MindTap isn’t just a tool; it’s backed by a personalized team eager to support you. We can help set up your course and tailor it to your specific objectives, so you’ll be ready to make an impact from day one. Know we’ll be standing by to help you and your students until the final day of the term. 19455_fm_hr_i-xxxi.indd 21 1/24/18 3:36 PM
- 29. xxii Preface Becker CPAExam Questions To help students prepare for taking the CPA exam, for each chapter, students have access to four or five representative multiple-choice questions from the Becker test bank, tailored to each chapter’s most critical learning objectives. ACL analytics and audit software with updated cases. This edition integrates ACL software into end-of-chapter materials. An ACL Appendix and tutorial is located at the end of the text.The ACL Appendix con- tains an overview of the basic functions of ACL followed by a brief, illustrated tutorial to help students learn how to use the basic features of the ACL Analyt- ics. Access to the software can be provided by Instructors who are enrolled in the ACL Academic Network program. ACL cases include the following: 1. Pell Grants, a fraud investigation case related to this student grant program. (Chapter 6) 2. Husky Accounts Receivable, which includes exercises in which students identify unpaid invoices and sales made over credit limits, perform cutoff analyses, conduct aging analyses, and identify procedures to be performed based upon their results. (Chapter 9) 3. FloorMart Sales and Inventory, which requires students to identify store locations in which data appear to indicate potential inaccuracies, and to identify procedures to gather additional evidence. (Chapter 9) 4. Husky Inventory, which includes exercises in which students identify potentially obsolete inventory, calculate inventory turnover, consider possible write-downs, and prepare a report based on their results. (Chapter 11) 5. Benford’s Law Case, a fraud case dealing with employee expense reimbursements and the application of Benford’s Law of numbers. (Chapter 14) Organization of the Eleventh Edition The demand for quality auditing: Chapter 1. Chapter 1 provides the foundation for students to understand the economic context in which financial statement auditing exists. The chapter defines the objective of financial statement auditing and describes its role in meet- ing society’s demands for reliable financial and internal control informa- tion. Chapter 1 introduces the Financial Reporting Council’s Audit Quality Framework, and identifies professional conduct requirements that help auditors achieve high quality. This chapter also provides frameworks for professional and ethical decision making. Chapter 1 also describes the pro- cess by which audit firms make client acceptance and continuance decisions, and recognizes that this process is important to achieving audit quality. Risk assessment with a focus on fraud and internal controls over financial reporting: Chapters 2 and 3. Chapter 2 defines fraud, describes the fraud triangle, and provides examples of recent financial reporting frauds.The chapter discusses users’ expectations of auditors’ fraud-related responsibilities, explains how various require- ments of the Sarbanes-Oxley Act of 2002 help prevent fraud, and discusses the importance of corporate governance in relation to quality auditing. Chapter 3 articulates the importance of internal control over financial reporting, defines internal control, identifies and describes the components 19455_fm_hr_i-xxxi.indd 22 1/24/18 3:36 PM
- 30. Preface xxiii and principlesof internal control, and describes management’s responsibil- ity related to internal control. Chapter 3 also explains how to distinguish between material weaknesses, significant deficiencies, and control deficien- cies in internal control over financial reporting. Important elements of the professional environment and the audit opinion formulation process: Chapters 4, 5, and 6. Chapter 4 discusses the liability environment in which auditors operate, explores the effects of lawsuits on audit firms, identifies laws from which auditor liability is derived, and describes possible remedies, sanctions, and auditor defenses. Chapter 5 identifies and compares auditing standards that provide audit guidance on the audit opinion formulation process, and discusses the foun- dational principles underlying these standards. The chapter lists the phases and related activities in the audit opinion formulation process, explains the concept of accounting cycles, describes the assertions that are inherent to financial statements, defines audit evidence and the purpose and types of audit procedures used to obtain audit evidence, and discusses the impor- tance of audit documentation. Chapter 6 discusses the importance of evidence sufficiency and appro- priateness, illustrates professional judgments about the type and timing of audit procedures, discusses the use and application of substantive analytical procedures, identifies issues relating to audit evidence needed for accounts involving management estimates, and discusses evidence issues involving specialists and related party transactions. Chapter 6 also describes the characteristics of quality audit documentation and explains the nature, design, and purposes of audit programs. Planning the audit and employing appropriate audit tools: Chap- ters 7 and 8. Chapter 7 defines the concept of material misstatement and discusses the importance of materiality judgments in the audit context. The chapter also identifies the risks of material misstatement and describes how they relate to audit risk and detection risk. Chapter 7 illustrates how auditors respond to assessed risks of material misstatement. In planning how to respond to assessed risk of material misstatements, auditors need to determine which of the available specialized tools they will use. Chapter 8 describes how auditors can use sampling techniques and data analytics tools to gather and evaluate sufficient appropriate audit evidence. The chapter explains the objectives of sampling for testing controls and account balances, compares and contrasts nonstatistical and statistical sampling, describes attributes sampling, describes the sampling process used to gather evidence about misstatements in account balances and assertions, describes monetary unit sampling, and explains how to use data analytics tools to obtain and evaluate audit evidence. Performing Audits Using theTransaction Cycle Approach: Chapters 9, 10, 11, 12, and 13. These five chapters focus on the application of concepts developed earlier for assessing risk, identifying and testing controls designed to address those risks, and using substantive approaches to testing account balances. Each chapter: • identifies significant accounts, disclosures, and relevant assertions • explains the process of identifying and assessing inherent risks, fraud risks, and control risks 19455_fm_hr_i-xxxi.indd 23 1/24/18 3:36 PM
- 31. xxiv Preface • describesplanning analytical procedures that the auditor can use to identify potential material misstatement • articulates appropriate responses to identified risks of material mis- statement, including appropriate tests of controls and considering results of tests of controls • and identifies how to apply substantive audit procedures. Completing a quality audit and issuing the audit report: Chapters 14 and 15. Chapter 14 discusses the procedures that auditors conduct while com- pleting the audit. These procedures include reviewing activities relating to detected misstatements, loss contingencies, disclosure adequacy, non- compliance with laws or regulations, review analytical procedures, going- concern matters, and subsequent events. The chapter also distinguishes between a management representation letter and a management letter, identifies procedures that are part of an engagement quality review, and identifies issues the auditor should communicate to the audit committee and management. Once these activities are completed, the auditor makes a reporting decision, which is described in Chapter 15. This chapter identifies the principles underlying audit reporting on financial statements, describes the information that is included in an unqualified/unmodified audit report, and describes financial statement audits resulting in an unqualified/unmodified audit opinion with report modifications. The chapter describes financial statement audits resulting in a qualified opinion, an adverse opinion, or a disclaimer of opinion. Chapter 15 describes the emerging critical audit matters (PCAOB) and key audit matters (IAASB) disclosures that audi- tors will, or already are, including in the auditor’s report. The chapter also describes the information that is included in a standard unqualified audit report on internal control over financial reporting and identifies the appropriate audit report modifications for situations requiring other than an unqualified report on internal control over financial reporting. Chapter 15 concludes with a discussion of how auditors should respond to situations in which omitted procedures come to light after the audit report has been issued. Supplements Companion Site: Instructors and students can find most of the textbook’s support materials online at login.cengage.com., including the solutions manual, PowerPoint slides,ACL data spreadsheet files, and other resources. Solutions Manual: The solutions manual contains the solutions to all end-of-chapter assignments. It is available on the instructor’s page at www .cengagebrain.com. PowerPoint Slides: Instructors can bring their lectures to life with engaging PowerPoint slides that are interesting, visually stimulating, and paced for student comprehension. These slides are ideal as lecture tools and provide a clear guide for student study and note-taking. We have purposely pro- vided more slides rather than less! We encourage instructors to tailor down the slides to meet their own, individual instructional preferences. Test Bank: Cengage Learning Testing Powered by Cognero is a flexible, online system that allows you to: 19455_fm_hr_i-xxxi.indd 24 1/24/18 3:36 PM
- 32. Preface xxv • author,edit, and manage test bank content from multiple Cengage Learning solutions, • create multiple test versions in an instant, • deliver tests from your LMS, your classroom, or wherever you want. The test bank is also available in Microsoft Word. The eleventh edition integrates the use of ACL software into both home- work and cases. An appendix and tutorial located at the end of the text- book provide guidance for students unfamiliar with the software. Access to the software can be provided by instructors who are enrolled in the ACL Academic Network program. Access to the software for qualified instructors and their students can be arranged with ACL through the Academic Network program: http:// info.acl.com/Academic-Network-for-Professors.html and http://info.acl. com/Academic-Network-Program_Professor-Sign-up.html. The signup process may take a few weeks to process so first-time instructors should sign-up for the program in advance of their teaching semester. Once instructors join the Academic Network, they will have access to: • ACL GRC - a cloud-based platform for audit management (includ- ing electronic workpapers) • ACL Analytics • ACL Launchpad - the single access point for ACL GRC, ACL Analytics, as well as support, ScriptHub, and ACL Academy • Analytical Procedures: A Case in the Context of the Pharmaceutical Industry (Chapters 9, 11, and 13): The case contains online Excel files that students download and analyze. The case enables students to practice developing and conducting planning and substantive analytical procedures. We developed the case using the published financial statements of three prominent companies in this indus- try, with adaptations to make the case suitable for classroom use. Students will access an Excel file on the companion site at login. cengage.com. The Excel file contains financial data and informa- tion from footnote disclosures. We view these exercises as one type of data analytic technique – one that individual instructors may be more comfortable using than emerging data analytics such as Tableau or other similar platforms. Acknowledgments We are grateful to members of the staff at Cengage for their help in developing the eleventh edition: Matt Filimonov, Senior Product Manager; Emily Lehmann, Associate Content Developer; Sangeetha Vijay, Content Project Manager at SPi Global; and Emily McLellan, Marketing Manager. Karla M. Johnstone Audrey A. Gramling Larry E. Rittenberg 19455_fm_hr_i-xxxi.indd 25 1/24/18 3:36 PM
- 33.
- 34. xxvii Karla M. Johnstone KarlaM. Johnstone, Ph.D., CPA, is the Ernst Young (EY) Professor of Accounting and Information Systems at the University of Wisconsin–Madison, School of Business. She teaches auditing, and her research investigates a broad range of auditing topics, including: curriculum enhancements in auditing, along with auditor decision making; client acceptance and continuance deci- sions; how fraud risk and fraud brainstorming affect audit planning and audit fees; client–auditor negotiation; competitive bidding; audit budget-setting processes; and governance responses to various negative corporate events such as fraud or internal control material weakness disclosures. Professor Johnstone serves on the editorial boards of numerous academic journals and is active in the Auditing Section of the American Accounting Association (AAA). She recently completed a term as the President of the Auditing Section. Before beginning her coursework for her Ph.D., Karla worked as a corporate accountant and as a staff auditor and was a doctoral fellow in residence at Coopers Lybrand. Importantly, Karla’s research and interactions with prac- tice—both in the U.S., and abroad (e.g., the Foundation for Audit Research in the Netherlands)—demonstrate a significant commitment to the theory and practice of auditing, along with associated regulatory and standards-setting activities. Audrey A. Gramling Audrey A. Gramling, Ph.D., CPA, CIA is the Accounting Department Chair and Professor at Colorado State University. Previously, she held the Treece Endowed Chair and was Accounting Department Professor and Chair at Bellarmine University. She has been on the accounting faculty at Kennesaw State University, Georgia State University, Wake Forest University, and University of Illinois at Urbana-Champaign. Audrey’s research inves- tigates both internal and external auditing issues, with a focus on decision behavior of auditors, external auditor independence, internal control report- ing, and other factors affecting the market for audit and assurance services. Prior to earning her Ph.D. at the University of Arizona, Audrey worked as an external auditor at a predecessor firm of Deloitte and as an internal auditor at Georgia Institute of Technology. She has also served a one-year appointment as an Academic Accounting Fellow in the Office of the Chief Accountant at the U.S. Securities and Exchange Commission. She is a past-President of the Auditing Section of the American Accounting Association and has served in an advisory role to the Committee of Sponsoring Organizations (COSO). In February 2018 she began serving as a member of the AICPA’s Auditing Standards Board. For over three decades, in recognition of the valuable role of auditing as a key component of corporate governance, Audrey has been committed to both the practice and theory of quality auditing. About the Authors 19455_fm_hr_i-xxxi.indd 27 1/24/18 3:36 PM
- 35. xxviii About theAuthors Larry E. Rittenberg Larry E. Rittenberg, Ph.D., CPA, CIA, is Professor Emeritus, Department of Accounting and Information Systems, at the University of Wisconsin– Madison, where he taught courses in auditing, risk management, and cor- porate governance. He is also Chair Emeritus of the COSO of the Treadway Commission, where he provided oversight of the development of the COSO Enterprise Risk Management Framework, the COSO Guidance for Smaller Businesses, and was instrumental in developing the Framework for COSO 2013. He has served as Vice-Chair of Professional Practices for the Institute of Internal Auditors (IIA) and President of the IIA Research Foundation, and has been a member of the Auditing Standards Committee of the AAA Audit- ing Section, the NACD Blue Ribbon Commission on Audit Committees, the IIA’s Professional Practices Committee, and Vice-President and Treasurer of the AAA. He recently retired as audit committee chair and board member of Woodward Governor, a publicly traded company, and has consulted on audit committee, risk, and control issues with Petro China – the largest public company in China. Professor Rittenberg served as a staff auditor for Ernst Young and has co-authored five books and monographs and numerous research articles. Recommendations from Instructors Who Have Used OurTextbook Previously Professor Tim Bell, University of North Florida. I have used [this] text for seven years now and it has been an outstanding resource for teaching my students the fundamentals of contemporary auditing. Text discussions and end-of-chapter applications help me to develop students’ critical analysis and judgment skills, sensitivity and responses to ethical dilemmas, and under- standing and appreciation of the essential role of professional skepticism in auditing…. My impression based on use of successive editions of the text is that the authors have worked very hard to ensure it is up-to-date as auditing standards and related guidance evolve and audit-relevant events occur in the rapidly-changing business environment. Without reservation, I highly recom- mend this text. Professor Veena L. Brown, University of Wisconsin-Milwaukee. This text- book is ideal for my students as it presents a good mix of theory and practice using the integrated audit approach. The authors do a great job portraying the auditing concepts in a deceptively simple manner. The Exhibits and the Professional Judgment in Context presented in each chapter helps students better grasp the sometimes-elusive auditing concepts. I have successfully used this textbook for the past six years and look forward to exploring the next edition with my students. Professor Barry J. Bryan, Southern Methodist University. I selected this text- book because I believe that it presents a realistic approach to the integrated audit. Having worked with several of the Big Four firms, it is evident to me that the authors have been diligent in writing a book that mirrors the risk- based approach to the audit. In addition, my students have enjoyed outstand- ing success on the AUD Exam having used this text as their primary study resource. Professor Sean Dennis, University of Kentucky. I use this book because it has it all… detailed (yet intuitive!) explanations, challenging review questions for students, and detailed cases that are both timely and relevant.The authors have organized the material in a way that helps students build an understanding of risk and the audit process from the ground up. The questions and cases at the end of the chapters also help create engaging discussions among students that 19455_fm_hr_i-xxxi.indd 28 1/24/18 3:36 PM
- 36. About the Authorsxxix lead to productive critical thinking. In fact, my favorite thing about this book is that the authors continually update the cases at the end of the chapters. This has really helped my students relate to the course material – and I use these cases in class as much as I can! Professor Denise Hanes Downey, Villanova University. The beauty of this textbook is that it facilitates an appreciation for the many nuances and complexities of auditing without overwhelming students. The authors appro- priately balance necessary details with illustrations and recent examples to guide students’ understanding. As a result, students come into class ready to engage in higher level discussions – having mastered the fundamentals on their own. From a course design perspective, I appreciate how the chapters stand-alone allowing professors to select chapters they find to be of par- ticular importance without requiring additional chapters be added to the syllabus for clarity. Professor Kim Westermann, California Polytechnic State University. As a for- mer auditor and current audit professor, I find the book very easy to follow and well written. The content is organized in a similar fashion to the audit pro- cess itself, which I think is essential for students’ understanding. The authors also include topics that I have not found in any other auditing textbook (e.g., an entire chapter on corporate governance, sections on upcoming changes or changes soon to be integrated into the profession). This textbook simply feels more up to date about current events in auditing. How CanYou Learn by Leveraging the Features of thisTextbook? Follow these ten steps: 1. Before you even begin, go online to MindTap via login.cengage.com and complete the first Becker CPA Exam Pre-test, which the authors have personally tailored to the chapters and learning objectives in this textbook. There is a 25-question Pre-test relating to Chapters 1–8, and another 25-question Pre-test relating to Chapters 9–15. In addition, these same tests are available online as Becker CPA Exam Post-tests, so that you can track your knowledge progress both within this course, as well as relating to the upcoming CPA exam. 2. For each chapter, start by viewing the Audit Opinion Formulation Process diagram at the outset of the chapter. Relevant chapter topics are highlighted for your reference so that you can track your progress through learning about all of the phases of conducting a quality audit. 3. Take a few minutes to read the What’s Covered feature in the chapter, which briefly describes the main themes of the chapter. Then, review the Learning Objectives. Just as you begin to read the chapter, quickly read the What You Will Learn questions. Engaging in these simple and quick actions will help you know what to expect out of each chapter, which research shows will help you organize your knowledge and recall it later (during exams!). 4. To help set the practical application for each chapter, read the Why It Matters feature at the outset of each chapter.This feature will help you see beyond the factual insights provided in the chapters. Elements include for example, extensions based on in-the-news examples that illustrate fundamental features and applications of text facts, professional standards in foreign jurisdictions, and interesting points that may be tangential to the text facts, but that should facilitate your deep engagement with the chapter. In addition, we highlight some of these features as relating to an InternationalFocus. (Continues) 19455_fm_hr_i-xxxi.indd 29 1/24/18 3:36 PM
- 37. xxx About theAuthors 5. The 15 chapters are split into a variety of clearly articulated learning objectives, each containing its own important insights. Within these objectives, you will encounter the following helpful learning take-aways that we intend to engage your critical thinking about the conceptual contents of each chapter: “Prompt for Critical Thinking—It’s Your Turn!” feature. This feature encourages you to engage in critical thinking as you acquire knowledge relevant to each chapter. This feature is intentionally creative in form and substance, and varies widely in structure based upon the learning objective to which it is related. We also provide potential answers to these prompts at the end of the chapter so that you can compare your thoughts about these prompts to those that the authors provide. “What Do You Think?—For Classroom Discussion” feature. This feature provides an avenue by which you can expect that the will use to facilitate preparation for class, encourage cognitive engagement, and facilitate critical thinking through discussions with other students. You have the opportunity to learn by preparing for these discussions, and engaging with the instructor and your classmates. Your employers and their clients will take as a given that you are proficient in your technical knowledge; what will set you apart from other young professionals is to express clearly articulated perspectives on the matters at hand; use these features as practice in rising to this challenge! 6. At the conclusion of each learning objective, complete the Check Your Basic Knowledge feature, which contains two true-false questions and two multiple-choice questions. Your instructor will provide you with answers to these questions, so you can compare your existing knowledge with the correct facts as you expand your understanding of textbook materials. 7. Fraud prevention and detection is one of the most important roles that auditors play in providing assurance with respect to financial reporting. Carefully read and be prepared to discuss in class the examples of auditors’roles in this regard in the Focus on Fraud feature. 8. Attend to the Exhibits and Figures! These lists and diagrams will be very helpful to you as you organize your knowledge in preparation for both the exams in this class, as well as the CPA exam. 9. Examine the Let’s Review feature at the end of each chapter to ensure that you have a solid understanding of the basic concepts of the chapter. Review the Significant Terms list and use it as a way to review your understanding of the material that you have read about within the chapter. As you do this review, develop a set of questions for any topics whereby you lack understanding. Impress your instructor by drafting some formative questions whereby you can challenge the in-class lecture on these topics. 10. Complete the End-of-Chapter Review Questions, Cases, and Application Activities that your instructor requires, and view them not as a burden, but rather as an opportunity for you to thoughtfully engage these topics. Doing so will enable you to properly categorize these ideas for later retrieval and use, both in the CPA exam and in your professional job. Continued 19455_fm_hr_i-xxxi.indd 30 1/24/18 3:36 PM
- 38.
- 39. Chapters 14 and 15 IV.Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions Chapters 8–13 III. Obtaining Evidence About Internal Control Operating Effectiveness Chapters 8–13 II. Performing Risk Assessment Chapters 2, 3, 7, and 9–13 I. Making Client Acceptance and Continuance Decisions Chapter 1 Professional Liability Chapter 4 The Audit Opinion Formulation Process and a Framework for Obtaining Audit Evidence Chapters 5 and 6 V. Completing the Audit and Making Reporting Decisions Quality Auditing and the Need for Quality Auditor Judgments and Ethical Decisions Chapter 1 The Audit Opinion Formulation Process 1 Quality Auditing: Why It Matters 19455_ch01_hr_002-055.indd 2 1/22/18 8:18 PM
- 40. 3 Learning Objectives LO 1Describe decision makers’needs for reliable financial and internal control information, and discuss how a financial statement audit helps meet those needs. LO 2 Define audit quality and list drivers of audit quality provided in the Financial Reporting Council’s Audit Quality Framework. LO 3 Identify professional conduct requirements that help auditors achieve audit quality. LO 4 Describe and apply frameworks for professional and ethical decision making. LO 5 Describe factors considered by audit firms making client acceptance and continuance decisions. The Importance of Conducting a Quality Audit and Complying with Professional Requirements This feature highlights that audit quality is an international issue. In March 2017, the Public Company Accounting Oversight Board (PCAOB) announced sanctions against a former partner of Price- waterhouseCoopers Auditores Independentes in Brazil for audit failures and violations of PCAOB rules and standards. Wander RodriguesTeles was the lead partner for PwC-Brazil’s audit work in connection with the audits of Sara Lee’s FYE 2007 through FYE 2011 consolidated financial statements. U.S.-based PricewaterhouseCoopers LLP (“PwC-US”) prepared and issued the audit reports on Sara Lee’s consolidated financial statements, which were filed with the U.S. Securities and Exchange Commis- sion. In 2012, Sara Lee restated its 2010 and 2011 financial results, citing accounting irregularities in its Brazil operations, including the overstatement of accounts receivable. The PCAOB found that Teles failed to adequately respond to indications that one of Sara Lee’s subsidiaries may have overstated its accounts receivable. When conducting the audit, Teles knew that a material amount of the subsidiary’s accounts receivable was overdue and disputed by customers. He was also aware that the subsidiary was extending the due dates of overdue receivables. The re-aging of receivables in this manner could cause overdue receivables to appear current. The PCAOB found that Teles failed to adequately respond to these risks with due professional care and professional skepticism, and failed to obtain sufficient evidence to support his audit conclusions. In the settled disciplinary order, Teles was censured, fined $10,000, and barred for two years from associating with a regis- tered public accounting firm. In discussing this case, PCAOB Chairman James R. Doty noted, “Audit quality is a global issue. As this order demonstrates, the Board is committed to investigating and disciplining auditors who present risks to investors in the U.S. markets, regardless of where the audit is conducted.” For further details, see PCAOB Release No. 105-2017-007. Why It Matters: An International Perspective What’s Covered Decision makers need reliable information to make many types of decisions, including investing and lending decisions. If these decision makers receive unreliable information, they may lose confidence in the information, make poor decisions, and lose money. External auditors help enhance the reliability of the information used by these decision makers by performing a quality financial statement audit. 19455_ch01_hr_002-055.indd 3 1/22/18 8:18 PM
- 41. 4 Chapter 1• Quality Auditing: Why It Matters An Overview of External Auditing Decision Makers’ Need for Reliable Information and the Role of a Financial Statement Audit External auditors perform an important task. While managers within organiza- tions produce financial statements and design internal control systems, external auditors performing a financial statement audit provide independent assur- ance on the reliability of the financial statements and, as part of an integrated audit, provide independent assurance on internal control effectiveness. Decision makers need information that is transparent and unbiased— information that does not favor one user over another. However, the interests of the various users can conflict. Current shareholders might want management to use accounting principles that result in higher levels of reported income, while lending institutions might prefer management to use a conservative approach to valuation and income recognition. Exhibit 1.1 identifies potential financial state- ment users and the decisions they make based on financial and internal control information. Why do financial statement users need independent assurance on reliability of information provided by management? Shouldn’t users expect management • What is a financial statement audit, and how does it pro- vide financial statement users with enhanced informa- tion reliability? (LO 1) • What skills and knowledge do auditors need? (LO 1) • What is audit quality, and why is it vital to perform an audit in a quality manner? (LO 2) • What professional conduct requirements aid auditors in conducting a quality audit? (LO 3) • What frameworks can auditors use to make professional and ethical decisions? (LO 4) • Why are client acceptance and continuance decisions important to audit quality? (LO 5) What You Will Learn LO 1 Describe decision makers’ needs for reliable financial and internal control information, and discuss how a financial statement audit helps meet those needs. Exhibit 1.1 Users of Audited Financial Statements User Types of Decisions Management Review performance, make operational decisions, and report results to capital markets Stockholders Buy or sell stock Bondholders Buy or sell bonds Financial institutions Evaluate loan decisions, considering interest rates, terms, and risk Taxing authorities Determine taxable income and tax due Regulatory agencies Develop regulations and monitor compliance Labor unions Make collective bargaining decisions Court system Assess the financial position of a company in litigation Vendors Assess credit risk Retired employees Protect employees from surprises concerning pensions and other post-retirement benefits 19455_ch01_hr_002-055.indd 4 1/22/18 8:18 PM
- 42. An Overview ofExternal Auditing 5 to provide reliable information? The need for independent assurance arises from several factors: • Potential bias—Management might have incentives to bias financial infor- mation to convey a better impression of the financial data than circum- stances would merit. For example, when management’s compensation is tied to profitability or stock price, managers may be tempted to “bend” generally accepted accounting principles (GAAP) to make the organization’s perfor- mance look better. • Remoteness—An organization and the users of its financial information are often remote from each other, both in terms of geographic distance and the extent of information available to the both parties. Most users cannot interview management, tour a company’s plant, or review its financial records; instead, they must rely on financial statements to com- municate the results of management’s performance. These factors can tempt management to keep information from users or bend GAAP so the organization looks better. • Complexity—Transactions, information, and processing systems are often very complex, so it can be difficult to determine their proper presentation. This factor provides an opportunity for management to mislead users. • Consequences—When financial information is not reliable, investors and other users lose a significant source of information that they need to make decisions that have important consequences. Without reliable financial information, users may invest in securities or may lend money to a company that is committing a fraud, and once the fraud is revealed users are in a position of losing significant amounts of money. Financial statement audits help increase the confidence that users can place on management-prepared information. Users of audited information need to have confidence in the objectivity and accuracy of the opinions provided by exter- nal auditors. Thus, external auditors need to be independent when performing a financial statement audit. Independence, often referred to as the cornerstone of the auditing profession, requires objectivity and freedom from bias. Without independence, audits lack value. Auditors must not only be independent in fact, but they must act in a manner that ensures that they are independent in appearance. For example, if an audit partner’s uncle was the CEO at the partner’s client company, users could rea- sonably worry about a conflict of interest. It is entirely possible that the audit partner has, in fact, an independent mental attitude. However, the audit part- ner would not appear to be independent in this scenario. Further complicating Auditors Must Be Mindful of their Role as Guardians of the Capital Markets This feature makes the point an auditor should make decisions in the public interest rather than in the interest of management. Auditors are hired by their clients, so in some sense they owe an allegiance to clients’interests. However, the most critical role that auditors play is providing independent assurance to investors, lenders, workers, and others who make decisions based on the client’s financial and internal control information. Auditors, there- fore, need the highest level of technical competence, freedom from bias, and concern for the integrity of the financial reporting process. Why It Matters 19455_ch01_hr_002-055.indd 5 1/22/18 8:18 PM
- 43. 6 Chapter 1• Quality Auditing: Why It Matters matters, management and the audit committee expect cost-effective audits. Audi- tors face many pressures—keeping fees low, making careful decisions regarding independence, and conducting a quality audit. What Is a Financial Statement Audit? A financial statement audit is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of corre- spondence between those assertions and established criteria; and communicating the results to interested users.1 The overall objective of an audit is to obtain reasonable assurance about whether the financial statements are free from material misstatement and to report on the financial statements based on the auditor’s findings. To accomplish these objec- tives, the auditor: • Complies with relevant ethical and professional conduct requirements • Conducts the audit in accordance with professional auditing standards • Exercises professional judgment, professional skepticism, and critical thinking • Obtains sufficient appropriate evidence, via a structured process, on which to base the auditor’s opinion We refer to the structured process used by auditors to accomplish their objectives as the audit opinion formulation process. Exhibit 1.2 presents that process. Phase I addresses client acceptance and continuance decisions. Auditors are not required to perform audits for any organization that asks; auditors choose whether to perform each individual audit. Audit firms have procedures to help them ensure that they are not associated with clients where management integrity is in question or where a company might otherwise present the audit firm with unnecessarily high risk (such as client financial failure or regulatory action against the client). Does Owning Stock in an Audit Client Affect Auditor Independence? This feature provides an interesting example of an audit senior violat- ing auditor independence rules. In 2005, Susan Birkert was an audit senior working for KPMG on the audit engagement of Comtech Corporation. One of Susan’s friends asked her whether she thought that Comtech stock was a good investment. She responded that, indeed, it was a good investment. At that point, her friend asked if she would like him to purchase Comtech stock on her behalf. She agreed and gave her friend $5,000 to make the purchase under his name rather than hers. She did so because she was aware that owning stock in one’s audit client is not allowed because of independence concerns. If auditors own stock in their audit clients, they are not independent of their clients because they are part owners. Therefore, rather than acting in an unbiased manner during the conduct of the audit, they might make judgments that favor the client company rather than external users of the financial state- ments. Even if the auditor does not actually behave in a biased manner and is independent in fact, external users may perceive an independence conflict—the auditor would not be independent in appearance. Susan continued working on the Comtech engagement well into 2006, and she lied when she responded to KPMG’s yearly writ- ten requirements to comply with the firm’s independence policies. Prompted by an anonymous tip later in 2006, KPMG launched an internal investigation into the matter and terminated her employ- ment. The PCAOB barred her from serving as an external auditor for a period of at least one year. For further details, see PCAOB Release No. 105-2007-003. Why It Matters 19455_ch01_hr_002-055.indd 6 1/22/18 8:18 PM
- 44. An Overview ofExternal Auditing 7 Next, in Phase II the auditor performs risk assessment procedures to thor- oughly understand the client’s business (or update prior knowledge in the case of a continuing client), its industry, its competition, and its management and gov- ernance processes (including internal controls) to determine the likelihood that financial accounts might be in error. These assessments also include the risk of fraud. In some audits, the auditor also obtains evidence about internal control operating effectiveness through testing those controls (Phase III). In Phase IV, the auditor obtains substantive evidence about accounts, disclo- sures, and assertions. The information gathered in Phases I through III greatly influences the amount of testing performed in Phase IV. Finally, in Phase V the auditor will complete the audit and make a decision about what type of audit report to issue. Exhibit 1.2 notes that the five phases occur in an environment where auditors conducting a quality audit need to make quality judgments and ethical decisions, and are subject to legal liability. The foundation for the audit opinion formulation process relies on obtaining audit evidence to support the audit opinion. When the auditor has no objections about management’s financial statements or internal controls, the auditor issues an unqualified audit report. Exhibit 1.3 provides an example of this type of report. Exhibit 1.3 indicates that the audit firm, PricewaterhouseCoopers, has provided two opinions. One opinion states that the audit firm has confidence that the financial statements of Ford are fairly stated. The other opinion states that PricewaterhouseCoopers has confidence that Ford’s internal control over financial reporting was effective as of Ford’s year-end, December 31, 2016. PricewaterhouseCoopers provided these opinions after going through a sys- tematic process of objectively obtaining and evaluating sufficient appropriate Exhibit 1.2 The Audit Opinion Formulation Process Chapters 14 and 15 IV. Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions Chapters 8–13 III. Obtaining Evidence About Internal Control Operating Effectiveness Chapters 8–13 II. Performing Risk Assessment Chapters 2, 3, 7, and 9–13 I. Making Client Acceptance and Continuance Decisions Chapter 1 Professional Liability Chapter 4 The Audit Opinion Formulation Process and a Framework for Obtaining Audit Evidence Chapters 5 and 6 V. Completing the Audit and Making Reporting Decisions Auditing Profession, Audit Quality, and the Need for Quality Judgments and Ethical Decisions Chapter 1 19455_ch01_hr_002-055.indd 7 1/22/18 8:18 PM
- 45. 8 Chapter 1• Quality Auditing: Why It Matters Exhibit 1.3 Integrated Audit Report Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Ford Motor Company In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, equity and cash flows present fairly, in all material respects, the financial position of Ford Motor Company and its subsidiaries at December 31, 2016 and December 31, 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all mate- rial respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in InternalControl-IntegratedFramework(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and the financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presen- tation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projec- tions of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Detroit, Michigan February 9, 2017 Source: http://shareholder.ford.com/~/media/Files/F/Ford-IR/annual-report/2016-annual-report.pdf. NOTE:The format of this report for public companies will be different effective for fiscal years ending on or after December 15, 2017. We discuss the new report formats in Chapter 15. evidence. If the auditor had objections about the fair presentation of the financial statements, the audit report would be modified to explain the nature of the audi- tor’s objections (for further details, see Chapter 15). If the auditor had reservations about the effectiveness of the client’s internal controls, the auditor would issue an adverse opinion on internal controls. 19455_ch01_hr_002-055.indd 8 1/22/18 8:18 PM
- 46. An Overview ofExternal Auditing 9 Parties Involved in Preparing and Auditing Financial Statements Various parties are involved in preparing and auditing financial statements and related disclosures; Exhibit 1.4 describes these parties and their roles. Manage- ment has responsibilities for: (a) preparing and presenting financial statements in accordance with the applicable financial reporting framework; (b) designing, implementing, and maintaining internal control over financial reporting; and (c) providing auditors with information relevant to the financial statements and internal controls. The internal audit function provides management and the audit committee with assurance on internal controls and reports. The audit committee, a subcom- mittee of the organization’s board of directors, oversees both management and the internal auditors; they also hire and oversee the external auditor. The external auditor’s job is to obtain reasonable assurance about whether management’s statements are materially accurate and to provide a publicly avail- able report. External auditors conduct their procedures and make judgments in accordance with professional standards (for further details, see Chapter 5). Those who have an interest in the organization will use the audited financial statements for various purposes. Providers of External Auditing Services The external auditing profession includes sole-practitioner firms, local and regional firms, and large multinational professional services firms such as the Big 4. The Big 4 firms are KPMG, Deloitte Touche Tohmatsu (Deloitte in the United States), PricewaterhouseCoopers (PwC), and EY. The organizational structure of these firms is quite complex. For example, each of the Big 4 firms is a network of mem- ber firms. Each of the member firms enters into agreements to share a common name, brand, and quality standards. In most cases, member firms organize as a partnership or limited liability corporation within each country. Some smaller firms also practice internationally through an affiliation with a network of firms. For example, a number of regional or local firms belong to an ORGANIZATION Management Maintains Internal Controls and Prepares Reports Internal Audit Function Provides Internal Assurance on Internal Controls and Reports Audit Committee Provides Oversight of the Reporting Process and Other Parties External Auditor Provides Independent Audit of Internal Controls and Financial Statements Financial Statements and Related Disclosures Along with the Auditor’s Reports Disseminated to Users Exhibit 1.4 Parties Involved in Preparing and Auditing Financial Statements 19455_ch01_hr_002-055.indd 9 1/22/18 8:18 PM
- 47. 10 Chapter 1• Quality Auditing: Why It Matters affiliation of such firms under the name of Moore Stephens, and another group operates under the name of Baker Tilly. Many public accounting firms have also organized their practices along indus- try lines. Common industry lines include financial services, retailing, not-for-profit, manufacturing, and government. The organizational hierarchy of audit firms is structured with partners (or owners) at the top level; these individuals are responsible for the overall conduct of each audit. Next in the hierarchy are managers, who review the audit work performed by seniors and staff personnel. Seniors are responsible for overseeing the day-to-day activities on a specific audit, and they oversee staff auditors and interns who perform many of the basic auditing procedures. Partners and manag- ers are simultaneously responsible for many audit engagements, whereas seniors and staff are usually assigned to fewer audits at one time. Skills and Knowledge Needed by External Auditors The requirements for external auditors are demanding. Auditors complete tasks requiring considerable technical knowledge and expertise; auditors must under- stand accounting and auditing authoritative literature, develop industry and client- specific knowledge, develop and apply computer skills, evaluate internal controls, and assess and respond to fraud risk. In addition to having appropriate technical knowledge, auditors need well- developed skills in leadership, teamwork, communication, decision-making, critical thinking, and general professionalism. In terms of general professionalism, auditors make presentations to manage- ment and audit committee members, exercise logical reasoning, communicate deci- sions to users, manage and supervise others by providing meaningful feedback, act with integrity and ethics, interact in a team environment, collaborate with others, and maintain a professional presence. A credential that auditors use to let the public know that they have the appro- priate knowledge and skills to conduct an audit is the CPA license. A CPA is a certified public accountant who is licensed by a state board of accountancy. A CPA license is the profession’s highest standard of competence, a symbol of achieve- ment and assurance of quality. A CPA license holds its owner to a high standard of ethical conduct, no matter where the individual is in his or her career. To earn a CPA license, you are required to demonstrate knowledge and competence by meet- ing high educational standards, passing the CPA exam, and completing a specific amount of general accounting experience. The Need for CriticalThinking This feature emphasizes the need for auditors to be critical thinkers throughout the audit opinion formulation process. Critical thinking is a rational response to questions that cannot be answered definitively and for which all the relevant information may not be available. Critical thinking is an investigation whose purpose is to: (1) analyze a problem, (2) arrive at a conclusion that integrates all available information, and (3) justify that conclusion convincingly to others. Auditorsmakemanydecisionsthroughouttheauditthatrequire critical thinking. These decisions including assessing the risk associ- ated with a client, determining the appropriate audit procedures to perform,evaluatingthesufficiencyofevidencecollected,andresolv- ing detected misstatements in the client’s financial statements. Why It Matters 19455_ch01_hr_002-055.indd 10 1/22/18 8:18 PM
- 48. Achieving Audit Quality11 Achieving Audit Quality Financial statement users expect a quality audit. What is a quality audit? One definition describes a quality audit as one performed “in accordance with gener- ally accepted auditing standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are (1) presented in accordance with GAAP and (2) are not materially misstated whether due to errors or fraud.”3 The Financial Reporting Council’s Audit Quality Framework identifies five primary drivers of audit quality, including (1) audit firm culture, (2) the skills and personal qualities of audit partners and staff, (3) the effectiveness of the audit process, (4) the reliability and usefulness of audit reporting, and (5) factors outside the control of auditors that affect audit quality. Exhibit 1.5 contains an overview of the FRC’s Audit Quality Framework that recognizes effective audit processes, by themselves, are not sufficient to achieve audit quality. Rather, a combination of five factors influences audit quality. 1-1 When the auditor has no reservations about management’s financial statements or internal controls, the auditor will issue an unqualified audit opinion. (T/F) 1-2 The sole responsibility of management with regard to financial reporting involves preparing and presenting financial statements in accordance with the applicable financial reporting framework. (T/F) 1-3 Which of the following are the responsibilities of the external auditor in auditing financial statements? a. Maintaining internal controls and preparing financial reports. b. Providing internal assurance on internal control and financial reports. c. Providing internal oversight of the reporting process. d. Providing independent assurance on the financial statements. 1-4 Which of the following factors does not create a demand for external audit services? a. Potential bias by management in providing information. b. Requirements of the state boards of accountancy. c. Complexity of the accounting processing systems. d. Remoteness between a user and the organization. Check Your Basic Knowledge What Do You Think? For Classroom Discussion External auditing is a“special function”as described by Chief Jus- tice Warren Burger in a 1984 Supreme Court decision: By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employ- ment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. This“public watchdog” function demands . . . complete fidelity to the public trust.2 Auditors serve a number of parties.Which party is the most impor- tant? Do you agree with Chief Justice Burger’s characterization of the auditor as a public watchdog? LO 2 Define audit quality and list driv- ers of audit quality provided in the Financial Reporting Council’s Audit Quality Framework. 19455_ch01_hr_002-055.indd 11 1/22/18 8:18 PM
- 49. Exploring the Varietyof Random Documents with Different Content
- 50. himself of anArabic work to write a half true and half fabulous history of Granada, and to intersperse it with favourite romances. There is a counterfeit edition of this work, entitled, Historia de las guerras civiles de Granada, Paris, 1660. From the French words on the margin, it is obvious that the book must have been used in Paris in the seventeenth century, for learning the Spanish language. 122 It will be sufficient to transcribe here one of these pastoral romances, which presents a fair specimen of the better part of the rest. Olvidada del sucesso, del engañado Narciso, mirando està en una fuente Filis su rostro divino, el negro cabello suelto, al ayre vano esparzido, ceñida la blanca frente con un liston amarillo. Mira los hermosos ojos, y el labio en sangre teñido de los cristalinos dientes adornado y ofendido: no se mira el bello rostro, por presuncion que ha tenido, mas porque le mueve a ello el desprecio de su amigo. Hala dexado el cruel, sin averlo merecido, por quien vale menos que ella, y es della menos querido. Pareciole que enturbiava con las perlas que ha vertido las corrientes amorosas,
- 51. y solloçando, lesdixo: Turbias van las aguas madre, turbias van, mas ellas se aclararàn. Si el agua de mi alegria enturbia la de mis ojos, y le ofrecen mis despojos al alma en mi fantasia, sospechas son, que algun dia tiempo y amor desharan. Turbias van las aguas madre, turbias van, mas ellas se aclararàn. Si fatiga el pensamiento, y se enturbia la memoria, juntar la passada gloria con el presente tormento, si esparzidos por el viento mis tristes suspiros van. Turbias van las aguas madre turbias van, mas ellas se aclararàn. 123 The following is written in a style which was, at a later period, much admired in France, and frequently imitated in Germany while Hagedorn and Gleim flourished:— Que se case un don Pelote con una dama sin dote, Bien puede ser. Mas que no de algunos dias por un pan sus damerias, No puede ser. Que pida a un galan Minguilla
- 52. cinco puntos deservilla. Bien puede ser. Mas que calçando diez Menga, quiera que justo la venga, No puede ser. Que la biuda en el sermon de mil suspiros sin son, Bien puede ser. Mas que no los de a mi cuenta, porque sepan do se assienta, No puede ser. Que ande la bella casada bien vestida, y mal zelada, Bien puede ser. Mas que el bueno del marido no sepa quien da el vestido, No puede ser. c. 124 See the notices of Nicolas Antonio, Sarmiento, Velasquez, and others. 125 It is entitled Romancero general, en que se contienen todos los romances, que andan impresos, aora nuevamente añadido y enmendado, Madrid, 1604, a quarto volume, containing about seventy sheets. The preface is subscribed by the bookseller, who seems to have compiled this work himself. The todos on the title page must not be literally understood. Not one of the romances contained in the old Cancionero de Romances, (see note page 53) appear in this Romancero general, which is, in other respects, extremely copious. But the Spanish booksellers began at an early period to give boasting titles to their publications.
- 53. 126 More copiousinformation, together with bibliographic notices respecting the pastoral dialogue of Mingo Rebulgo, are given by Velasquez and Dieze, page 162. 127 Sarmiento, page 235, quotes this specimen of Juan de la Enzina’s Disparates:— Anoche do madrugada, Ya despues de medio dia, Vi venir en romeria Una nube muy cargada c. No despues de mucho rato Vi venir un orinal Puesto de pontifical c. 128 Nicolas Antonio, Sarmiento, and Velasquez, give accounts of Juan de la Enzina. Some of his romances and songs, which however, possess no remarkable merit, are also contained in the Cancionero general and the Cancionero de romances. One of his compositions, styled an echo, or a song, in which the rhyme is repeated in the following word, with the effect of an echo, is inserted in the Cancionero general, as being something peculiar. The old collection, entitled, Cancionero de todas las obras de Juan del Enzina, certainly contains poems far superior to any already mentioned, though perhaps they do not rise above the poetry of his age. Velasquez quotes an edition published in 1516, which Dieze regards as a curiosity. Indeed one of the greatest literary curiosities in existence, is an old folio edition, (probably the first) of the Cancionero of Juan de la Enzina, printed at Seville, in gothic characters, in the year 1501, by two Germans named Pegnitzer and Herbst, at the expense of two merchants. The copy to which I have referred, which is
- 54. probably the onlyone in Germany, is also mentioned in Dieze’s supplement to Velasquez; it belongs to the Ducal library at Wolfenbüttel. Notwithstanding the gothic characters, the print is so clear and neat, that in this respect alone it is highly interesting to bibliographists. Juan de la Enzina’s songs occupy the greater part of the volume. One of them, namely—an Apology for Women, (Contra los que dicen mal de Mugeres) is remarkable for poetic truth and pleasing versification. In this Apology for the fair sex, the author, among other things, says: Piadosas en dolerse De todo ageno dolor, Con muy sana fe y amor, Sin su fama escurecerse, Ellas nos hacen hacer De nuestros bienes franquezas; Ellas nos hacen poner A procurar y querer Las virtudes y noblezas. Ellas nos dan ocasion, Que nos hagomas discretos, Esmerados y perfetos, Y de mucho presuncion. Ellas nos hacen andar Las vestiduras polidas, Los pundonores guardar, Y, por honra procurar, Tener en poco las vidas. His imitations of Virgil’s eclogues have the same metrical form as many of his other poems. The first eclogue commences with the following graceful strophe:—
- 55. Tityro, tu sincuidado Que te estas so aqueste haya, Bien tendido y rellanado. Yo triste y descarriado Yo no sè, por do me vaya. Ay, carillo! Tañes tu tu caramillo, No hay que en cordoja te trayga. His sacred and profane pastoral dramas are merely eclogues in a style similar to the above, only that they are written in the dialogue form, and with remarkable lightness. The last, which is of the profane class, commences thus:— Gil. Ha, Mingo, que das de atràs? Pasa, pasa, acà delante! A horas que no se espante, Como tu, tu primo Bras. Asmo, que tu pavor has. Entra! No estes revellado! Mingo. Dò me a Dios, que estoy asmado. No me mandes entrar mas. 129 In the edition of 1599, which I have consulted, the work is entitled Celestina, tragicomedia de Calisto y Melibea. The first letter of each of the introductory stanzas, being put together, form the following words:—El bachiler Fernando de Rojas acabò la comedia de Calisto y Melibea, e fue nacido en la puebla de Montalvan.
- 56. 130 The followingspecimens may be cited. Callistus is discoursing with his servant, concerning his passion for Melibœa. Ca. Mayor es mi fuego, y menor la piedad de quien agora digo.—Sem. No me engaño que loco està aste mi amo.— Ca. Que estàs murmurando Sempronio?—Sem. No digo nada.—Ca. Di lo que dizes: no temas.—Sem. Digo que como pueda ser mayor el fuego que atormenta un bivo, que el que quemó tal ciudad y tanta multitud de gente?— Ca. Como? yo telo dire: mayor es la llama que dura ochenta años que la que en un dia passa; y mayor la que quema un anima, que la que quemó cien mil cuerpos. Como de la aparencia a la existencia, como de lo vivo a lo pintado; como de la sombra a lo real: tanta differencia ay del fuego que dizes al que me quema. Por cierto si el del purgatorio es tal, mas querria que mi espiritu fuesse con los de los brutos animales, que por medio de aquel yr a la gloria de los santos.—Sem. Algo es lo que digo, a mas ha de yr este hecho: no basta loco, sino hereje.—Ca. No te digo que hables alto quando hablares? Que dizes?—Sem. Digo que nunca Dios quiera tal: que es especie de herejia lo que agora dixiste.—Ca. Porque?—Sem. Porque lo que dizes contradize la Christiana religion.—Ca. Que a mi?— Sem. Tu no eres Christiano?—Ca. Yo Melibieo soy, e a Melibea adoro, e en Melibea creo, e a Melibea amo. 131 About the same period, the dramatic prose dialogue of Italy was formed in a similar style, but with more histrionic refinement. See vol. ii. of my history of Italian Literature. 132 The dramatic romance of Callistus and Melibœa, has been translated into several languages as a book of moral instruction. There is an old German translation which appeared at Nurnberg in 1520, entitled the Hurenspiegel.
- 57. The German philologist,Caspar Barth, translated it into Latin under the title of Pornoboscodidascalus, and styles it, Liber plane divinus. It was published at Frankfort on the Oder, in 1624. 133 One may become acquainted with these old Spanish chronicles with more facility than formerly; for during the last thirty years the greater part of them have been re- printed. A folio edition of the copious chronicle of Peres de Guzman was printed at Valencia, in the year 1779, with an elegance which proves the patriotic zeal of the editors: the chronicle of Ayala was printed at Madrid in the same year. Literature is indebted for this revival of the fathers of Spanish History, to the efforts of the Historical Academy of Madrid. 134 It is not many years since this history was first published from the manuscript. It is intitled, Cronica de Don Pedro Niño Conde de Buelna, por Gutierre Diez de Games, su Aferes. La publica D. Eugenio de Llaguno Amirola, c. Madrid, 1782, in quarto. 135 He gives the following description of the national character of the French, which derives additional attraction from its antiquated language:— Los Franceses son noble nacion de gente: son sabios é muy entendidos, é discretos en todas las cosas que pertenescen á buena crianza en cortesia é gentileza. Son muy gentiles en sus traeres, é guarnidos ricamente: traense mucho á lo propio: son francos é dadivosos: aman facer placer á todas las gentes: honran mucho los estrangeros: saben loar, é loan mucho los buenos fechos: non son maliciosos: dan pasada á los enojos: non caloñan á ome de voz nin fecho, salvo si los vá alli mucho de sus honras: son muy corteses é graciosos en su fablar: son
- 58. muy alegres, tomanplacer de buena mente, é buscanle. Asi ellos como ellas son muy enamorados, é precianso dello. 136 That this biographical chronicle was written between the years 1453 and 1460, is proved in the preface to the latest edition, which is entitled, Cronica de Don Alvaro de Luna, c. La publica con varios apendices Don Josef Miguel de Flores, Secretario perpetuo de la real Academia de la Historia. Madrid, 1784, 4to. 137 The following is one of his declamatory passages: it is certainly more suited to a philippic than to a biographic work, but it is sufficiently oratorical for the age in which it was produced:— Oh traycion! oh traycion! oh traycion! Maldito sea el ser tuyo: maldito sea el poder tuyo: é maldito el tu obrar, que á tanto se estiende, é tantas fuerzas alcanza. Oh enemiga de toda bondad, é adversaria de toda virtud, é contraria de todos bienes! Por tì han seìdo destruidos Reynos: por tí han seìdo asoladas grandes é nobles, é populosas cibdades: é por tì son cometidas en Emperadores, é Reyes, é Principes, é altos señores, crueles, bravas é miserables muertes. Quien pudiera pensar? Quien pudiera creer? O qu’al juicio pudiera abastar á considerar, que un tanto señor, é de tan alto ser, un tan grand, á tan familiar amigo de virtudes, como era el inclito Maestre de Sanctiago é insigne Condestable de la gran Castilla, viniesse al passo que agora aqui contaremos? 138 Entre los otros frutos abundosos que la España en otro tiempo de sì solia dar, fallo yo que el mas precioso de aquellos fué criar é nudrir en si varones muy virtuosos notables é dispuestos para enseñorear, sabios para regir, duros é fuertes para guerrear. De los quales unos fueron
- 59. subidos á lacumbre imperial, otros á la relumbrante catedra del saber. E muchos otros merescieron por victoria corona del triunfo resplandesciente. 139 E tentando entrar la presente obra donde pues tú, Verdad, eres una de las principales virtudes que en aqueste nuestro muy buen Maestre siempre fecistes morada, á tí solo llamo é invoco que adiestres la mi mano, alumbres el mi ingenio, abundes la mi memoria, porque yo pueda confirmar é sellar la comenzada obra con el tu precioso nombre. 140 The author thus relates how in his youth Don Alvaro de Luna, by the irresistible grace of his manners had gained the love of the king, who was then also very young, and the favour of the fair sex:— Ca si Rey salia á danzar, non queria que otro caballero ninguno, nin grande nin Rico ome danzase con él, salvo Don Alvaro de Luna, nin queria con otro cantar, nin facer cosa, salvo con Don Alvaro, nin se apartaba con otro á aver sus consejos é fablas secretas tanto como con él. De la otra parte que todas las dueñas é doncellas lo favorescian mucho. Don Alvaro era mas mirado é preciado entre todos aquellos que en las fiestas se ayuntaron. E despues quando el Rey se retraìa á su cámara á burlar ó aver placer, Don Alvaro burlaba tan cortés é graciosamente, que el Rey é todos los otros que con él eran avian muy grand placer. E si fablaban en fechos de caballeria, aunque Don Alvaro era mozo, él fablaba en ellos, assi bien é atentamente que todos se maravillaban. E aquel fué desde niño su mayor estudio, entender en los fechos de armas é de caballeria, é darse á ellos, é saber en ellos mas facer que decir.
- 60. 141 The libraryof the university of Göttingen contains a copy of this scarce book, printed in gothic characters, but the title page is wanting. It commences with the title of the table of contents: Comiença la tabla de los claros varones, ordenada por Fernando del Pulgar, c. The biographical sketches are followed by a collection of letters; and the whole forms a volume with which every author who writes on Spanish history ought to be acquainted. 142 The following specimen is the commencement of a jocular letter, in which Fernando del Pulgar begs of his physician to prescribe to him a remedy for the sciatica, as the consolation which Cicero offers in his book de Senectute had no effect on him:— Señor dotor Francisco Nuñes fisico: yo Fernando de Pulgar escrivano paresco ante vos: y digo que padesciendo grand dolor de la yjada: y otros males que asoman con la vejez quise leer a Julio de senetute para aver del para ellos algun remedio. Y no le de dios mas salud al alma de lo que yo falle en el para mi yjada. Verdad es que da muchas consolaciones: y cuenta muchos loores de la vejez. Pero no provee de remedio para sus males. Quisiere yo fallar un remedio solo, mas por cierto de Señor fisico que todos sus consolaciones por que el conorte quando no quita dolor, no pone consolacion. Quise ver essomismo el segundo libro que fizo de las quistiones Tosculanas. Do quiere provar que el sabio no deve haver dolor: y si lo hoviere lo puede desechar con virtud. E yo Señor dotor como no soy sabio senti el dolor. Y como no soy virtuoso no le puede desechar. Ni lo desechara el mismo Julio por virtuoso que fuera: si sintiera el mal que yo sinti. Assi que para las enfermedades que vienen con la vejez fallo que es mejor yr al fisico remediador: que al filosofo consolador. Por los Cipiones, por los Metellos, y sabios, y por los Trasos, y por otros algunos romanos que bivieron y
- 61. murieron en honraquiere provar Julio que la vejez es buena. Y por algunos que ovieron mala postremera provare yo que es mala. E dare mayor numero de testigos para prueva de mi intencion que el Señor Julio pudo dar para en prueva de la suya. 143 See the notice by Nicolas Antonio in the Bibl. Hisp. Vetus, last edition, (Madrid, 1788,) vol. ii. p. 282. 144 This treatise precedes the collection of Juan de la Enzina’s poems. See note page 131. 145 Criados en el gremio de la dulce filosofia. This he says in particular reference to Ferdinand and Isabella. 146 Quanta diferencia aya del Musico al Cantor, y del Geometra al Pedrero, tanta debe haver entre Poeta é Trobador. The third comparison follows afterwards. 147 An unpardonable neglect of chronology has given rise to a confusion of dates, by which this period of Spanish literature has been made to include two distinct epochs. This confusion is particularly striking in the work of Velasquez. In his third age of Castilian poetry, which he commences with the introduction of the Italian style, but which ought really to be called the second, he reckons all the Spanish poets, who appear to have formed their manner after Italian models down to the reign of Philip IV.; and in the following age, which he calls the fourth, he places Virnes, Lope de Vega, and others, who flourished half a century before. 148 See page 25. In the Cancionero general there are some spiritual sonnets, but they are all equally aukward and repulsive.
- 62. 149 The historyof the opposition which Boscan’s poetical reform experienced, is briefly related by himself in the dedication to the Duchess of Soma, which precedes the second volume of his poems. 150 The eighth volume of the Parnaso Español, by Sedano, contains a supplement to the biographical notices which Nicolas Antonio collected under the article Boscan, and Dieze adopted in his notes on Velasquez. The Noticias Biographicas, which Sedano has added to the Parnaso Español, deserve, from this epoch downward, to be carefully consulted. 151 The library of the university of Göttingen possesses a copy of perhaps the oldest edition of the works of this author, viz. Obras de Boscan, Lisboa 1543, in 4to., and another edition, Anvers 1569, in 8vo. 152 The first strophe runs thus:— El sentir de mi sentido Tan profundo ha navegado, Que me tiene ya engolfado, Donde vivo despedido De salir ni a pie ni a nado; c. 153 The spirit of Petrarch breathes in the following sonnet; though it is accompanied in the latter verses with a portion of romantic subtilty. Solo y pensoso en prados y desiertos mis passos doy cuydosos y cansados: y entrambos ojos traygo levantados à ver no vea alguien mis desconciertos.
- 63. Mis tormentos allivienen tan ciertos, y van mis sentimentos tan cargados, que aun los campos me suelen ser passados, porque todos no estan secos y muertos. Si oyo hablar à caso algun ganado, y la voz d’ el pastor da en mis oydos, alli se me rebuelve mi cuydado. Y quedan espantados mis sentidos, como ha sido no aver desesperado, despues de tantos llantos doloridos. 154 Passages such as the following from the beautiful Claros y frescos rios of Boscan, after Petrarch’s canzone Chiare, dolci e fresche acque, would be sought for in vain in the writings of Petrarch himself. Las horas estoy viendo en ella y los momentos, y cada cosa pongo en su sazon. Comigo aca la entiendo, pienso sus pensamientos, por mi saco los suyos quales son: dize m’ el coraçon, y pienso yo que acierta, ya esta alegre, ya triste, ya sale, ya se viste, agora duerme, agora esta despierta: el seso y el amor, andan por quien la pintara mejor. Viene me à la memoria donde la vi primero, y aquel lugar do comencè de amalla, y naceme tal gloria de ver como la quiero,
- 64. que es yamejor qu’ el vella el contemplalla. En el contemplar halla mi alma un gozo estraño, pienso estalla mirando, despues en mi tornando, pesame que dura poco el engaño: no pido otra alegria, sino engañar mi triste fantasia. 155 The following passage may serve for an example:— No oso pensar el dia y hora quando mis ojos començaron a mirarte, su vista poco a poco desmandando: Entonces comencè a considerarte, con pensamientos que y van y venian, y casi no era mas de imaginarte. Los unos blandamente me dezian, que con mi coraçon todo te amasse, los otros se alterava y temian. Fuerça fue en fin, que poco a poco entrasse a conocer mi triste entendimiento, que era bien que tus cosas contemplasse. Alli se levantò mi pensamiento haziendo su discurso en mil ojetos, y todos sobre un mismo fundamento. 156 A certain horatian epicurean spirit is recognizable in the view he takes of the philosophy of life. En tierra do los vicios van tan llenos, aquellos hombres que no son peores, aquellos passaran luego por buenos.
- 65. Yo no andoya siguiendo à los mejores, bastame alguna vez dar fruto alguno, en lo de mas contentome de flores. No quiero en la virtud ser importuno, ni pretendo rigor en mis costumbres, con el gloton no pienso estar ayuno. La tierra està con llanos y con cumbres, lo tolerable al tiempo acomodemos, y à su sazon hagamonos dos lumbres. Pictures of domestic happiness, partaking both of the manner of Horace and Tibullus, form an agreeable addition to Boscan’s moral reflections, viz. Comigo y mi muger sabrosamente estè, y alguna vez me pida celos, con tal que me los pida blandamente. Comamos y bevamos sin recelos, la mesa de muchachos rodeada; mochachos que nos hagan ser aguelos. Passeremos assi neustra jornada, agora en la ciudad ahora en la aldea, porque la vida estè mas descansada. Quando pesada la ciudad nos sea, yremos al lugar con la compaña, adonde el importuno no nos vea. Alli se vivira con menos maña, y no aura el hombre tanto de guardarse d’ el malo, o d’ el grossero que os engaña. Alli podra mejor philosopharse con los bueyes, y cabras, y ovejas, que con los que d’ el vulgo han de tratarse.
- 66. 157 The descriptionof Venus appearing, when the star which has obtained her name rises, is thus given:— Mostrava ya su resplandor la estrella, Que barre de la sombra neustra suelo, Y al su venir toda otra cosa bella Dexava su lugar alla en el cielo: Quando Venus salio, y al salir d’ ella Saliò el amor, y junto saliò el zelo, El zelo que de amor nace en las cosas, Y mas en las que nacen mas hermosas. Saliò con sus cabellos esprazidos, Esta reyna de amor y de hermosura, Su rostro blanco y blancos sus vestidos, Con gravedad mezclada con dulçura: Los ojos entre vivos y caidos, Divino el ademan y la figura, Como aquella que Zeuxis trasladó De las cinco donzellas de Crotò. 158 Some stanzas in the speech which the missionary Cupids address to the ladies of Barcelona, bring to recollection a passage in Tasso’s Jerusalem, though that poem did not then exist. N’ os engañe ni os trayga levantadas, La mocedad y verde loçania: Que os hallareys despues peor burladas, Con el tiempo que burla cada dia. Y de suerte os vereys desengañadas, Que engañaros querra la fantasia, Y n’ os valdra ni maña ni consejo, Ni miraros mil vezes al espejo. Guardad que mientras el buen tiempo dura,
- 67. No se ospierda la fresca primavera: Sali à gozar el campo y su verdura, Antes que todo en el invierno muera: Reposa y sossega en essa frescura, Con el ayre que blandamente os hierra, Y assi falsas podreys estar señoras, Sobre el correr d’el tiempo y de las horas. 159 Danubio, rio divino Que por fieras naciones Vas con tus claras ondas discurriendo, c. 160 In his elegy on Boscan he thus apostrophizes Mars:— O crudo, o riguroso, o duro Marte, De tunica cubierto de diamante, Y endurecido siempre en toda parte, c. 161 The edition of the Obras de Garcilaso de la Vega, Madrid, 1765, 8vo. published by an anonymous editor, contains impartial and correct remarks on the beauties and the defects of the author’s poetry. The preface which is written with a spirit of patriotic frankness is also worthy of perusal. 162 In the following sonnet the dull and affected close forms a disagreeable contrast to the fine commencement. La mar en medio y tierras he dexado De quanto bien, cuitado, yo tenía:
- 68. Y yéndome alejandocada dia, Gentes, costumbres, lenguas he pasado. Ya de volver estoy desconfiado; Pienso remedios en mi fantasía: Y el que mas cierto espero, es aquel dia Que acabará la vida y el cuidado. Do qualquier mal pudiera socorrerme Con veros yo, señora, ó esperallo, Si esperallo pudiera sin perdello. Mas de no veros ya para valerme, Sino es morir, ningun remedio hallo: Y si este lo es, tampoco podré habello. 163 It is as follows:— O dulces prendas, por mi mal halladas, Dulces y alegres, quando Dios queria! Juntas estays en la memoria mia, Y con ella en mi muerte conjuradas. Quien me dixera, quando las passadas Horas en tanto bien por vos me via, Que me haviais de ser el algun dia Con tan grave dolor representadas! Pues en un hora junto me llevastes, Todo el bien, que por terminos me distes, Llevadme junto el mal, que me dexastes. Si no, sospecharè, que me pusistes En tantos bienes, porque deseastes Verme morìr entre memorias tristes. When stripped, however, of the pleasing versification, the ideas in the last lines appear somewhat studied and far- fetched.
- 69. 164 The followingtwo strophes are from the lament of Salicio. Por ti el silencio de la selva umbrosa, Por ti la esquividad y apartamiento Del solitario monte me agradaba: Por ti la verde hierba, el fresco viento, El blanco lirio y colorada rosa, Y dulce primavera deseaba. Ay! quanto me engañaba, Ay! quan diferente era, Y quan de otra manera Lo que en tu falso pecho se escondía! Bien claro con su voz me lo decía La siniestra corneja repitiendo La desventura mia. Salid sin duelo lágrimas corriendo. Quantas veces durmiendo en la floresta (Reputándolo yo por desvarío) Vi mi mal entre sueños, desdichado! Soñaba que en el tiempo del estío Llevaba, por pasar allí la siesta, A beber en el Tajo mi ganado: Y despues de llegado, Sin saber de qual arte, Por desusada parte, Y por nuevo camino el agua se iba: Ardiendo yo con la calor estiva, El curso enajenado iba siguiendo Del agua fugitiva. Salid sin duelo lágrimas corriendo.
- 70. 165 Mas ya queá socorrerme aqui no vienes, No dexes el lugar que tanto amaste; Que bien podrás venir de mi segura. Yo dexaré el lugar do me dexaste: Ven, si por solo esto te detienes. Ves aquí un prado lleno de verdura, Ves aquí una espesura, Ves aquí una agua clara, En otro tiempo cara, A quien de ti con lágrimas me quexo. Quizá aquí hallarás, pues yo me alejo, Al que todo mi bien quitarme puede; Que pues el bien le dexo, No es mucho que el lugar tambien le puede. 166 Do están agora aquellos claros ojos, Que llevaban tras sí como colgada Mi ánima do quier que se volvian? Do está la blanca mano delicada Llena de vencimientos y despojos, Que de mi mis sentidos le ofrecían? Los cabellos que vian Con gran desprecio al oro Como á menor tesoro, Adonde están? Adonde el blanco pecho? Do la coluna que el dorado techo, Con presuncion graciosa sostenía? Aquesto todo agora ya se encierra,
- 71. Por desventura mia, Enla fria, desierta y dura tierra. 167 Una parte guardé de tus cabellos, Eliza, envueltos en un blanco paño, Que nunca de mi seno se me apartan: Descójolos, y de un dolor tamaño Enternecerme siento, que sobre ellos Nunca mis ojos de llorar se hartan, Sin que de allí se partan, Con suspiros calientes, Mas que la llama ardientes, Los enxugo del llanto, y de consuno Casi los paso y cuento uno á uno: Juntándolos con un cordon los ato: Tras esto el importuno Dolor me dexa descansar un rato. 168 Como acontece al mísero doliente, Que del un cabo el cierto amigo y sano Le muestra el duro mal de su acidente, Y le amonesta que del cuerpo humano Comience á levantar á mejor parte El alma suelta con volar liviano; Mas la tierna muger, de la otra parte, No se puede entregar al desengaño, Y encúbrele del mal la mayor parte: El, abrazado con su dulce engaño, Vuelve los ojos á la voz piadosa,
- 72. Y alégrase muriendocon su daño: Así los quito yo de toda cosa, Y póngolos en solo el pensamiento De la esperanza cierta ó lastimosa. En este dulce error muero contento; Porque ver claro, y conocer mi estado No puede ya curar el mal que siento; Y acabo como aquel que en un templado Baño metido sin sentido muere, Las venas dulcemente desatado. 169 In the title of the edition which I have perused of his Obras, (Madrid, 1610, in 4to.) the word “Hurtado” is omitted, and he is called simply Diego de Mendoza; but the Mendozas are so numerous in Spanish literature, that it is necessary to pay attention to all the distinctions in their names. 170 O embaxadores, puros majaderos, Que si los reyes quieren engañar, Comiençan por nosotros los primeros. Nuestro mayor negocio es, no dañar, Y jamas hacer cosa, ni dezilla, Que no corramos riesgo de enseñar. The passage is in the epistle commencing: Que hace el gran señor de los Romanos.
- 73. 171 They areto be found among his poems with these titles: —“Carta en redondillas, estando preso.”—“Redondillas, estando preso por una pendencia que tuvo en palacio.” 172 The best life of Mendoza is that which precedes his Guerra de Granada, Valencia, 1776, in quarto. The notices in the fourth volume of the Parnaso Español are also copious and useful. 173 It commences thus:— El no maravillarse hombre de nada Me parece, Boscan, ser una cosa, Que basta a darnos vida descansada; c. 174 The commencement relates to Boscan’s wife:— Tu la veràs Boscan, y yo la veo, Que los que amamos, vemos mas temprano, Hela, en cabello negro, y blanco arreo. Ella te cogera con blanda mano Las raras ubas, y la fruta cana, Dulces, y frescos dones del verano. Mira que diligencia, con que gana Viene al nuevo servicio, que pomposa Està con el trabajo, y quan ufana. En blanca leche colorada rosa Nunca para su amigo vi al pastor Mezclar, que pareciesse tan hermosa. El verde arrayan tuerce en derredor, De tu sagrada frente, con las flores, Mezclando oro immortal a la labor. Por cima van, y vienen los amores, Con las alas en vino remojadas,
- 74. Suenan en elcarcax los passadores. Remedie quien quisiere las pissadas De los grandes, que el mundo governaron, Cuyas obras, quiza estan olvidadas. Desuelese en lo que ellos no alcançaron, Duerma descolorido sobre el oro, Que no les quedara mas que llevaron. Yo Boscan, no procure otro tesoro, Sino poder vivir medianamente, Ni escondo la riqueza, ni la adoro. Si aqui hallas algun inconveniente, Como discreto, y no como yo soy, Me desengaña luego incontinente, Y sino ven conmigo adonde voy. 175 Quantos ay don Luys, que sobre nada Haziendo sumtuoso fundamento, Tienen la buena suerte por llegada. Cansanse con un vano pensamiento, Hechan sus conjeturas, y razones, Hazen torres vazias en el viento. Ensanchan al pensar los coraçones, Creen tener en puño la fortuna, Y toman por el pie las ocasiones. Como los simples niños que en la cuna, No saben conocer otro cuydado, Sino contar las vigas, una a una, Ansi passan la vida en descuydado, Y ternan por el mismo, sin mas duda, El tiempo por venir con el passado: Mas si el viento delante se les muda, Y arranca las arenas del profundo,
- 75. No por essoharán vida sessuda. No les podra quitar hombre del mundo El comer, el dormir, el passear, El tenerse por solos sin segundo. 176 Otros ay que rebuelven en el seno, El tiempo que es passado, y el que tienen, Consideran lo suyo por lo ageno. Toman las ocasiones que les vienen, Y las que no les vienen, van buscando, Y con qualquier tiempo se entre tienen. El mundo punto a punto van passando Los hombres por de dentro, y por defuera Como en anatomia examinando. Ponen la diligencia en delantera, El seso, y la razon por el guarismo, Quieren que todo venga a su manera. No tienen otra ley, ni otro bautismo, Sino lo que les cumple, y por solo esto Yran hasta el profundo del abismo. Agudos en el cuerpo, y en el gesto, Mal ceñidos, las capas arrastradas, El ojo abierto, y el caminar presto. Si les suceden cosas desastradas, Escogen, y proveen lo peor, Nadie puede topar con sus pisadas. No toman el camino, que es mejor, Llano, y trillado, antes al reves, Engañanse en el arte, y la labor. 177 Words on which elisions are permitted in Italian, as for example, dar, legger, amor, peggior, instead of dare,
- 76. leggere, amore, peggiore,are in Spanish, by an invariable rule of the language, written dar, leèr, amor, peòr; and, on the other hand, no poet can presume to omit the terminating vowels in Spanish words. A succession of pure feminine rhymes is, therefore, as unnatural in the Spanish language as in the German. In the Spanish, however, the unnatural effect is easily concealed; while in the German, the incessant recurrence of the semi-mute e, in feminine rhymes, is intolerable. 178 The following is characteristic, since it presents in a picture of the poet’s mode of life, the mingled features of Italian refinement and the Spanish tone of thinking. Aora en la dulce ciencia embevecido, Ora en el uso de la ardiente espada, Aora con la mano, y el sentido Puesto en seguir la plaça levantada, Ora el pesado cuerpo estè dormido, Aora el alma atenta, y desvelada, Siempre en el coraçon tendre esculpido Tu ser, y hermosura entretallada. Entre gentes estrañas, do se encierra El Sol fuera del mundo, y se desvia, Durarè, y permanecerè deste arte. En el mar, en el cielo, so la tierra, Contemplarè la gloria de aquel dia, Que tu vista figura en toda parte. 179 One of those canciones commences in a sententious way in the horatian manner, but it soon degenerates into an obscurity, very unlike Horace. Tiempo bien empleado,
- 77. Y vida descansada, Bienque á pocos, y tarde se consiente Olvidar lo passado, Holgar con lo presente, Y de lo por venir, no curar nada, Hora falta, y menguada La del que nunca olvida Un cuydado que siempre le da pena. Cortado à su medida Tan importuna, y llena, Que ni otro halla entrada, ni el salida, Mas tiene por testigo Su pensamiento, y este es su enemigo. 180 See the Introduction, page 20. 181 For example:— Hagame lugar El placer un dia! Dexame contar Esta pena mia! 182 The following are the first stanzas of a song, which he composed in prison, after his extraordinary adventure in the court of Madrid:— Triste, y aspera fortuna Un preso tiene afligido, Mas no por esso vencido Con la fuerça de ninguna. Entre sus cuydados vive, Ellos mismos le atormentan,
- 78. Mil muertes lerepresentan, Y las mas dellos recibe. Y aunque no se rinde al peso De tantas penas, y enojos, Rinde à Filis los despojos De sus entrañas, y seso. Tristezas, y soledades, Y quexas muy apretadas, Que sino son declaradas, A lo menos son verdades. 183 In a half comic song, he describes jealousy (in Spanish los zelos, jealous thoughts), in a series of very odd, negative comparisons;—for example: No es padre, suegro, ni yerno, Ni es hijo, hermano, ni tio, Ni es mar, arroyo, ni rio, Ni es verano, ni es invierno, Ni es otoño, ni es estio. No es ave, ni es animal, Ni es Luna, sombra ni Sol, Vequadrado, ni vemol, Piedra, planta, ni metal, Ni pece, ni caracol. Tampoco es noche, ni dia, Ni hora, ni mes, ni año, Ni es lienço, seda, ni paño, Ni es Latin, ni Algaravia, Ni es ogaño, ni fue antaño 184 The only editions of the vida de Lazarillo de Tormes now in circulation, are printed after that published at Saragossa,
- 79. in the year1652, with de Luna’s corrections and continuation. 185 A new edition of this work, which is entitled:—Guerra de Granada, que hizo el rey don Felipe II. c. Escriviòla D. Diego Hurtado de Mendoza, has been mentioned in the note, p. 193. It is in fact the first correct edition, for in it the original text is restored by collation with the genuine MS. 186 This affectation of style is particularly observable in the Proœmium; and therefore that part of the work does not create a very favourable prepossession towards the author, in the mind of the impartial critic:— Bien sè que muchas cosas de las que escriviere pareceràn a algunos livianas, i menudas para Historia, comparadas a las grandes, que de España se hallan escritas; Guerras largas de varios sucesos, tomas i desolaciones de Ciudades populosas, Reyes vencidos i presos, discordias entre padres i hijos, hermanos i hermanas, suegros i hiernos, desposeidos, restituidos, i otra vez desposeidos, muertos a hierro, acabados linages, mudadas successiones de Reinos; libre i estendido campo, i ancha salida para los Escritores. Yo escogi camino mas estrecho, trabajoso, esteril, i sin gloria; pero provechoso, i de fruto para los que adelante vinieren; comienzos bajos, rebelion de salteadores, junta de esclavos, tumulto de villanos, competencias, odios, ambiciones, i pretensiones; dilacion de provisiones, falta de dinero, inconvenientes o no creidos, o tenidos en poco. 187 For example: Porque la Inquisicion los comenzò a apretar mas de lo ordinario. El Rei les mandò dejar la habla Morisca, i con
- 80. ella el comercioi comunicacion entre si; quitòseles el servicio de los Esclavos negros a quienes criavan con esperanzas de hijos, el habito Morisco en que tenian empleado gran caudal; obligaronlos a vestir Castellano con mucha costa, que las mugeres trugesen los rostros descubiertos, que las casas acostumbradas a estar cerradas estuviesen abiertas: lo uno i lo otro tan grave de sufrir entre gente celosa. Huvo fama que les mandavan tomar los hijos, i pasallos a Castilla. Vedaronles el uso de los baños, que eran su limpieza i entrenimiento; primero les havian prohibido la Musica, cantares, fiestas, bodas, conforme a su costumbre, i qualesquier juntas de pasatiempo. Saliò todo esto junto sin guardia, ni provision de gente; sin reforzar presidios viejos, o firmar otros nuevos. 188 This speech is forcibly written, and the style is no where disfigured by rhetorical ornament. The following is one of its most powerful passages:— Quien quita que el hombre de Lengua Castellana no pueda tener la lei del Profeta? i el de la lengua Morisca la lei de Jesus? llaman a nuestros hijos a sus Congregaciones i casas de letras, enseñanles artes que nuestros mayores prohibieron aprenderse; porque no se confundiese la puridad, i se hiciese litigiosa la verdad de la lei. Cada hora nos amenazan quitarlos de los brazos de sus madres, i de la crianza de sus padres, i pasarlos a tierras agenas; donde olviden nuestra manera de vida, i aprendan a ser enemigos de los padres que los engendramos, i de las madres que los parieron. Mandannos dejar nuestro habito, vestir el Castellano. Vistense entre ellos los Tudescos de una manera, los Franceses de otra, los Griegos de otra, los Frailes de otra, los mozos de otra, i de otra los viejos; cada Nacion, cada profesion i cada estado usa su manera de vestido, i todos
- 81. son Christianos; inosotros Moros, porque vestimos a la Morisca; como si truxesemos la lei en el vestido, i no en el corazon. 189 Demàs desto proveerse de vitualla, eligir lugar en la montaña donde guardalla, fabricar armas, reparar las que de mucho tiempo tenian escondidas, comprar nuevas, i avisar de nuevo a los Reyes de Argel, Fez, Señor de Tituan desta resolucion i preparaciones. 190 In the year 1737, that excellent critic Mayans, in allusion to Diego de Mendoza’s Guerra de Granada, observes:—Deve leerse, como el la escriviò. Quiere Dios que algun dia la publique yo! (Orig. de la Lingua Española, vol. i. p. 205). Thus even at that period a genuine edition, such as Mayans wished to superintend, could not be published. 191 Dieze, it is true, alledges the contrary, in his notes on Velasquez; but it appears that he was acquainted only with the pastoral poems, and not with the other works of Saa de Miranda. 192 These Spanish pastoral poems are mingled indiscriminately with the Portuguese poems of the same author, in the neatly printed edition of the Obras do Doctor Francisco de Sà de Miranda, Lisboa, 1784, in 2 vols. 8vo. No attention has been paid to the correction of the Spanish poems in this collection, and Portuguese words continually occur in them; for example, as for las, pensamentos for pensamientos, outro for otro, c. The orthography of the title-page is uncommon; for in other cases the Portuguese spelling is not doctor, but doutor, and Sà is a modern substitution for Saa. 193 The following stanza may certainly claim a place in the best epic poem.
- 82. Como el pinoen el monte combalido Del impetuoso viento en la tormenta, A quantos que lo ven pone en recelo, Los truenos amenazan, arrebienta El fuego por las nuves, exlo erguido, Exlo coruo que vâ cayendo al suelo, Hasta tanto que el Cielo Se abre en llama ardiendo, Entre viendo, y no viendo, El bravo rayo en bueltas mil desciende, Aquel prostrero mal quien se defiende? Queda un tronco quemado, y cuento breve, A quien passa porende, O busca alli quiça que a casa lleve. 194 For example:— Graciosamente estando, Graciosamente andando, Blando ayre respirava al prado ameno. Ella cantava, y juntamente el seno Inchiendose yva de diversas flores, En que el prado era lleno Sobre verde variado en mil colores. 195 For instance, the following passage in the second eclogue: — A que parte se es yda esta alma mia? Quien me la enseñarà? yo que hago aqui? Sin alguno de dos, que antes tenia? Que entr’ambas se ajuntáran contra mi?
- 83. Solo dexado mehan, ciego, y sin guia. Pareceos esto amor? dexarme ansi? Consigo no quisieran allà llevarme Ni buelto me han a ver, ni a consolarme. Como una llama por el monte ardiente, Que presto en alto buela, y no parece, De vista se nos pierde en continente, Y el humo turbio solo remanece, Otra tal claridad resplandeciente, Mientras mirando estava, eis se escurece Ansi tan presto? triste a donde yrè? Sin ti y allá sin ti, triste que harè? 196 Can any thing be more charming than the following passage from the seventh eclogue? A nymph gazes on a sleeping shepherd. Duerme el hermoso donzel, No zagal, no pastor, no, Mientras al sueño se diò, Mi alma diosele a el. El Sol es alto, y con el Del dia, es ido un buen trecho No sè que de mi se hà hecho, Serà lo que fuere del. Loca de mi, que a mirar Me puse, y dixe tal viendo, Quien tanto aplaze dormiendo, Despierto, que es de pensar? Quiseme luego apartar, No se quien me buelve aqui. Ah quan tarde que entendi, Que peligro es començar.
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