OVER 750 QUESTIONS AND 55 TASK-BASED SIMULATIONS! CPA EXAM REVIEW. Auditing and Attestation. O. Ray Whittington, CPA, PhD Patrick R.

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1 OVER 750 QUESTIONS AND 55 TASK-BASED SIMULATIONS! 2012 CPA EXAM REVIEW Auditing and Attestation O. Ray Whittington, CPA, PhD Patrick R. Delaney, CPA, PhD

3 WILEY CPA EXAM REVIEW

5 WILEY EXAM REVIEW Auditing and Attestation O. Ray Whittington, CPA, PhD Patrick R. Delaney, CPA, PhD JOHN WILEY & SONS, INC.

6 The following items, Copyright by the American Institute of Certified Public Accountants, Inc., are reprinted with permission: 1. Material from Uniform CPA Examination Questions and Answers, 1978 through Example audit reports from Statements on Auditing Standards and Statements on Standards for Accounting and Review Services. 3. Information for Uniform CPA Examination Candidates, Board of Examiners, Material from AU 319 (SAS 55 and SAS 78) and an AICPA Audit Guide, both titled Consideration of Internal Control in a Financial Statement Audit. 5. Material from AICPA Auditing Procedures Studies: Consideration of the Internal Control Structure in a Computer Environment: A Case Study; Auditing with Computers; Auditing in Common Computer Environments; Audit Implications of EDI. 6. Material from the Certified Internal Auditor Examination, Copyright 1994 through 1997 by the Institute of Internal Auditors, Inc., are reprinted and/or adapted with permission. 7. Material from the Certified Management Accountant Examinations, Copyright 1993 through 1997 by the Institute of Certified Management Accountants, are reprinted and/or adapted with permission. Material adapted, with permission, from Writing for Accountants, Aletha Hendrickson, South-Western Publishing Co., This book is printed on acid-free paper. Copyright 2012 by John Wiley & Sons, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate percopy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, , fax , or on the Web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, , fax , or online at go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the US at , outside the US at or fax Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our Web site at ISBN (paperback); (ebk); (ebk); (ebk) Printed in the United States of America

7 CONTENTS Preface About the Authors About the Contributor vii ix ix INTRODUCTION Chapter 1: Beginning Your CPA Review Program 3 Chapter 2: Examination Grading 15 Chapter 3: The Solutions Approach 16 Chapter 4: Taking the Examination 23 Chapter 5: Exam Content Overview 27 AUDITING AND ATTESTATION Module 1: Professional Responsibilities 49 Module 2: Engagement Planning, Obtaining an Understanding of the Client and Assessing Risks 93 Module 3: Understanding Internal Control and Assessing Control Risk 152 Module 4: Responding to Risk Assessment: Evidence Accumulation and Evaluation 235 Module 5: Reporting 316 Module 6: Accounting and Review Services 386 Module 7: Audit Sampling 421 Module 8: Auditing with Technology 455 Outlines of Professional Standards 471 Information Technology Supplement 587 APPENDICES Appendix A: Auditing and Attestation Sample Examination 617 Appendix B: Sample Auditing and Attestation Testlet Released by the AICPA 643 Appendix C: 2011 Released AICPA Questions for Auditing and Attestation 650 INDEX 671

9 PREFACE Passing the CPA exam upon your first attempt is possible! The Wiley CPA Examination Review preparation materials provide you with the necessary materials (visit our Web site at for more information). It s up to you to add the hard work and commitment. Together we can beat the pass rate on each section of about 45%. All Wiley CPA products are continuously updated to provide you with the most comprehensive and complete knowledge base. Choose your products from the Wiley preparation materials and you can proceed confidently. You can select support materials that are exam-based and user-friendly. You can select products that will help you pass! Remaining current is one of the keys to examination success. Here is a list of what s new in this edition of the Wiley CPA Examination Review Auditing and Attestation text. The AICPA Content Specification Outlines on Auditing and Attestation for the Computerized CPA Examination beginning in 2011 AICPA questions released in 2011 The new task-based simulations Coverage of new audit and attestation standards, especially DON T FORGET TO VISIT OUR WEB SITE AT FOR SUPPLEMENTS AND UPDATES. Latest AICPA auditing, ethics, and quality control standards Latest Public Company Accounting Oversight Board auditing standards International auditing standards The objective of this work is to provide you with the knowledge to pass the Auditing and Attestation portion of the Uniform Certified Public Accounting (CPA) Exam. The text is divided up into eight areas of study called modules. Each module contains written text with discussion, examples, and demonstrations of the key exam concepts. Following each text area, actual American Institute of Certified Public Accountants (AICPA) unofficial questions and answers are presented to test your knowledge. We are indebted to the AICPA for permission to reproduce and adapt examination materials from past examinations. Author constructed questions and simulations are provided for new areas or areas that require updating. All author constructed questions and simulations are modeled after AICPA question formats. The multiple-choice questions are grouped into topical areas, giving candidates a chance to assess their areas of strength and weakness. Selection and inclusion of topical content is based upon current AICPA Content Specification Outlines. Only testable topics are presented. If the CPA exam does not test it, this text does not present it. The CPA exam is one of the toughest exams you will ever take. It will not be easy. But if you follow our guidelines and focus on your goal, you will be thrilled with what you can accomplish. Ray Whittington September 2011 vii

11 ABOUT THE AUTHORS Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the College of Commerce at DePaul University. Prior to joining the faculty at DePaul, Professor Whittington was the Director of Accountancy at San Diego State University. From 1989 through 1991, he was the Director of Auditing Research for the American Institute of Certified Public Accountants (AICPA), and he previously was on the audit staff of KPMG. He previously served as a member of the Auditing Standards Board of the AICPA and as a member of the Accounting and Review Services Committee and the Board of Regents of the Institute of Internal Auditors. Professor Whittington has published numerous textbooks, articles, monographs, and continuing education courses. Patrick R. Delaney, deceased, was the dedicated author and editor of the Wiley CPA Exam Review books for twenty years. He was the Arthur Andersen LLP Alumni Professor of Accountancy and Department Chair at Northern Illinois University. He received his PhD in Accountancy from the University of Illinois. He had public accounting experience with Arthur Andersen LLP and was coauthor of GAAP: Interpretation and Application, also published by John Wiley & Sons, Inc. He served as Vice President and a member of the Illinois CPA Society s Board of Directors, and was Chairman of its Accounting Principles Committee; was a past president of the Rockford Chapter, Institute of Management Accountants; and had served on numerous other professional committees. He was a member of the American Accounting Association, American Institute of Certified Public Accountants, and Institute of Management Accountants. Professor Delaney was published in The Accounting Review and was a recipient of the Illinois CPA Society s Outstanding Educator Award, NIU s Excellence in Teaching Award, and Lewis University s Distinguished Alumnus Award. He was involved in NIU s CPA Review Course as director and instructor. ABOUT THE CONTRIBUTOR Kurt Pany, PhD, CPA, is a Professor of Accounting at Arizona State University. Prior to entering academe, he worked as a staff auditor for Deloitte and Touche. He is a former member of the AICPA s Auditing Standards Board and has taught in the Arizona CPA Review Course. ix

13 INTRODUCTION To maximize the efficiency of your review program, begin by studying (not merely reading) this chapter and the next three chapters of this volume. They have been carefully organized and written to provide you with important information to assist you in successfully completing the Auditing and Attestation section of the CPA exam. Beyond providing a comprehensive outline to help you organize the material tested on the Auditing and Attestation exam, Chapter 1 will assist you in organizing a study program to prepare for the exam. Self-discipline is essential. Chapter 1: Beginning Your CPA Review Program Chapter 2: Examination Grading Chapter 3: The Solutions Approach Chapter 4: Taking the Examination Chapter 5: Exam Content Overview

15 Chapter 1: Beginning Your CPA Review Program GENERAL COMMENTS ON THE EXAMINATION The Uniform CPA Examination is delivered using computer-based testing (CBT). Computer-based testing has several advantages. You may take the exam one section at a time. As a result, your studies can be focused on that one section, improving your chances for success. In addition, the exam is no longer offered twice a year. During eight months of every year, you may take the exam on your schedule, six days a week and in the morning or in the afternoon. Successful completion of the Auditing and Attestation section is an attainable goal. Keep this point foremost in your mind as you study the first four chapters in this volume and develop your study plan. Purpose of the Examination 1 The Uniform CPA Examination is designed to test the entry-level knowledge and skills necessary to protect the public interest. An entry-level CPA is defined as one who has fulfilled the applicable jurisdiction s educational requirements and has the knowledge and skills typically possessed by a person with up to two years of experience. These knowledge and skills were identified through a Practice Analysis performed in 2008, which served as a basis for the development of the content specifications for the exam beginning in As indicated in the new Content and Skills Specifications In addition to demonstrating knowledge and understanding of the professional standards, candidates are required to demonstrate the skills required to apply that knowledge in performing auditing and attestation tasks as certified public accountants.candidates are also expected to perform the following tasks: Demonstrate an awareness and understanding of the process by which standards and professional requirements are established for audit, attestation, and other services performed by CPAs, including the role of standard-setting bodies within the US and those bodies with the authority to promulgate international standards. Differentiate between audits, attestation and assurance services, compilations, and reviews. Differentiate between the professional standards for issuers and nonissuers. Identify situations that might be unethical or a violation of professional standards, perform research and consultations as appropriate, and determine the appropriate action. Recognize potentially unethical behavior of clients and determine the impact on the services being performed. Demonstrate the importance of identifying and adhering to requirements, rules, and standards that are established by licensing boards within their state, and which may place additional professional requirements specific to their state of practice. Appropriately apply professional requirements in practice, and differentiate between unconditional requirements and presumptively mandatory requirements. Exercise due care in the performance of work. Demonstrate an appropriate level of professional skepticism in the performance of work. Maintain independence in mental attitude in all matters relating to the audit. Research relevant professional literature. The CPA examination is one of many screening devices to assure the competence of those licensed to perform the attest function and to render professional accounting services. Other screening devices include educational requirements, ethics examinations, and work experience. The CPA examination appears to test the material covered in accounting programs of the better business schools. It also appears to be based upon the body of knowledge essential for the practice of public accounting and the audit of a medium-sized client. Since the examination is primarily a textbook or academic examination, you should plan on taking it as soon as possible after completing your required education. Examination Content Guidance concerning topical content of the computer-based exam in Auditing and Attestation can be found in a document prepared by the Board of Examiners of the AICPA entitled Content and Skill Specifications for the Uniform CPA Exam. We have included the content outline for Auditing and Attestation at the beginning of Chapter 5. The outline should be used as an indication of the topics relative emphasis on the exam. The Board s objective in preparing this detailed listing of topics tested on the exam is to help in assuring the continuing validity and reliability of the Uniform CPA Examination. These outlines are an excellent source of guidance concerning the areas and emphasis to be given each area on future exams. The new Content and Skill Specification Outlines for the CPA examination, including the testing of International Auditing Standards, went into effect January 1, In addition, the AICPA adopted CBT-e, which is a new computer platform. The major change from your standpoint is that simulations are smaller in size and a larger number of these 1 More information may be obtained from the AICPA s Uniform CPA Examination Candidate Bulletin, which you can find on the AICPA s Web site at 3

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