Principles of Auditing and Other Assurance Services
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O. Ray Whittington
CIA, CMA, CPA
Arizona State University
Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St. Louis
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PRINCIPLES OF AUDITING AND OTHER ASSURANCE SERVICES
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the
Americas, New York, NY, 10020. Copyright © 2007, 2004, 2001, 1998, 1995, 1992, 1989, 1988, 1985, 1982, 1977,
1973, 1969, 1964, 1959, 1953 by The McGraw-Hill Companies, Inc. All rights reserved. No part of this publication
may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without
the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or
other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the
This book is printed on acid-free paper.
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Library of Congress Cataloging-in-Publication Data
Whittington, Ray, 1948–
Principles of auditing and other assurance services / O. Ray Whittington, Kurt Pany.—
ISBN 0-07-301084-7 (alk. paper)
1. Auditing. I. Pany, Kurt. II. Title.
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About the Authors
O. Ray Whittington
O. Ray Whittington, CIA, CMA, CPA, serves as the Ledger and Quill Director of the School of
Accountancy at DePaul University. He received his B.B.A., M.S., and Ph.D. degrees from Sam
Houston State University, Texas Tech University, and the University of Houston, respectively.
Professor Whittington is an active textbook author on the subjects of auditing and audit sam-
pling. He has also published in a variety of journals, including The Accounting Review, The
Journal of Accounting Research, and Auditing: A Journal of Practice and Theory. He has served
as a member of the Board of Regents of the Institute of Internal Auditors and has served as
Chairman on the Auditing Standards Committee of the Auditing Section and the Bylaws
Committee, both of the American Accounting Association. Professor Whittington was until
recently a member of the AICPA Auditing Standards Board, and currently he is the President-
elect of the Auditing Section of the American Accounting Association.
Kurt Pany, CPA, CFE, is a Professor of Accounting at Arizona State University. He received his
B.S., M.B.A., and Ph.D. degrees from the University of Arizona, the University of Minnesota,
and the University of Illinois, respectively. He has also served as a staff accountant with Arthur
Andersen and Touche Ross, as a member of the Auditing Standards Board, and as an academic
fellow with the American Institute of Certiﬁed Public Accountants. Professor Pany has
published articles on auditing in such journals as The Journal of Accounting Research, The Ac-
counting Review, Auditing: A Journal of Practice and Theory, The Journal of Accountancy, and
The CPA Journal. He is a member of and has served on various committees of the American
Accounting Association, the American Institute of Certiﬁed Public Accountants, and the
Arizona Society of Certiﬁed Public Accountants.
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The past few years we have seen unprecedented changes in the auditing profession. These
changes were precipitated by the revelation that management of a number of large public com-
panies, including Enron and WorldCom, systematically misstated the ﬁnancial statements of
the companies over a number of years. As a result, we have witnessed congressional hearings
about the accounting profession, the criminal conviction and liquidation of the international
accounting ﬁrm of Arthur Andersen LLP, the passage of the Sarbanes-Oxley Act of 2002, and
the creation of the Public Company Accounting Oversight Board, which takes from the pro-
fession the major portion of its self-regulatory authority. The goal of the ﬁfteenth edition of
Principles of Auditing and Other Assurance Services is to provide you with a clear perspec-
tive of this new auditing environment.
How do we do this?
1. Balanced presentation. This text provides a carefully balanced presentation of auditing
and assurance theory and practice. The concepts are written in a clear, concise, and under-
standable manner suitable for students who have not had signiﬁcant audit experience. Real
company examples are integrated throughout the text to bring this material to life. Lastly,
Keystone Computers & Networks, Inc., the text’s illustrative audit case, is integrated into
selected chapters, providing students with hands-on audit experience.
2. Clarifying the changes to the profession. The authors have included all the new legal and
standards changes affecting the auditing profession to provide students with the most
current and up-to-date auditing text available.
3. CPA Exam Support. The text includes both multiple choice questions and simulations
aimed at helping students pass the new computerized CPA exam.
4. Maintaining a clear perspective. The Online Learning Center provides instructors and
students with a wealth of material to help keep students up-to-date. The OLC receives daily
updates from The New York Times and McGraw-Hill’s PowerWeb so you always know the
breaking news affecting the profession. The OLC also contains quizzes and other resources
to help students in this course.
Just as the cover provides a clear perspective of the environment outside, Principles of Audit-
ing and Other Assurance Services, 15/e, will provide students with a clear perspective of the
new auditing environment.
O. Ray Whittington
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Key Features of the Book
Sarbanes-Oxley Act of 2002 and the resulting Public Company
Accounting Oversight Board profoundly affect public accountants,
CPA ﬁrms, and their clients. Most notably, the public accounting
profession is no longer largely self-regulating, CPAs must issue a
publicly available report on the internal control of each publicly traded
client, and top management must certify the company’s ﬁnancial
statements, and provide an assessment of internal control over ﬁnancial
reporting. The text carefully integrates coverage of the act’s nature and
effects on the profession in selected chapters. Also included is coverage
of ﬁnancial frauds, such as those involving Enron and WorldCom,
which led to passage of the act.
The ﬁrst 9 chapters of the text emphasize the
philosophy and environment of the profession, 1. The Role of the Public Accountant in the
with special attention paid to the nature and American Economy
economic purpose of auditing and assurance
2. Professional Standards
services, professional standards, professional
conduct, legal liability, audit evidence, audit 3. Professional Ethics
planning, consideration of internal control, 4. Legal Liability of CPAs
audit sampling, audit documentation, and 5. Audit Evidence and Documentation
general records. 6. Planning the Audit; Linking Audit Procedures
Auditor legal liability in Chapter 4 is updated
based on suggestions by legal scholar 7. Internal Control
Professor Marianne Jennings of Arizona State 8. Consideration of Internal Control in an Information
University. Technology Environment
9. Audit Sampling
Chapter 6 includes the dramatic changes
required by Statement on Auditing Standards
No. 99, “The Auditor’s Consideration of Fraud
in a Financial Statement Audit.”
Chapters 7 and 8 reﬂect the profession’s most
recent pronouncements relating to information
technology and internal control.
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Keystone Computers & Networks, Inc., is the text’s Illustrative International Auditing Standards are
Audit Case. This feature has been updated in this edition and discussed as appropriate. These standards
illustrates audit methods and provides realistic, thought-provoking are becoming increasingly signiﬁcant with
case exercises. Although each portion of the case is designed to stand the development of international markets
alone, if used in combination, the case will help the student develop for securities.
problem-solving skills in planning (Chapter 6), in considering internal
control and testing account balances (Chapters 11 and 14), and in
completing the audit (Chapter 16). The case incorporates the use of
computerized accounting applications and also integrates the
fundamentals of audit sampling from Chapter 9.
Chapters 10 through 16 (the “procedural
10. Cash and Financial Investments chapters”) deal with internal control and
obtaining evidence about the various ﬁnancial
11. Accounts Receivable, Notes Receivable, and
statement accounts; they emphasize a risk-
Revenue based approach to selecting appropriate
12. Inventories and Cost of Goods Sold auditing procedures. They also provide a
13. Property, Plant, and Equipment: Depreciation description of the business risk approach to
and Depletion audits that has been adopted by many large
CPA ﬁrms and is the approach included in the
14. Accounts Payable and Other Liabilities
recently issued exposure draft of the proposed
15. Debt and Equity Capital Statement on Auditing Standards on Risk
16. Auditing Operations and Completing the Assessment. Chapters 10 through 16 also
Audit thoroughly integrate the requirements of SAS
17. Auditors’ Reports No. 99. Chapters 10, 11, 12, and 14 include a set
of interrelated simulations similar to those
18. Integrated Audits of Public Companies
included on the uniform CPA exam.
19. Additional Assurance Services: Historical
Financial Information Chapter 17 presents the auditors’ reporting
20. Additional Assurance Services: Other responsibilities for audits of ﬁnancial
Information statements for both public and nonpublic
21. Internal, Operational, and Compliance Auditing
Chapter 18, new to this edition, presents the
details of the audit of internal control over
ﬁnancial reporting required for public
Chapter 19 covers special reports and reports
arising from accounting and review
Chapter 20 presents a variety of attestation
and other assurance services. The material on
attestation services describes the current
professional standards. Other assurance
services are included at both a conceptual and
Chapter 21’s discussion of compliance auditing
has been modiﬁed based on the suggestions of
Mr. Norwood J. Jackson, former Deputy
Controller, Ofﬁce of Federal Management, U.S.
Ofﬁce of Management and Budget.
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NEW IN THIS EDITION
The Auditing & Attestation section of the Uniform Certiﬁed Public Accountant Exam represents 41⁄2 hours of that
14-hour examination. The AICPA indicates that each Auditing & Attestation exam will consist of multiple choice
questions and two condensed case studies referred to as simulations.
New to this edition, we have prepared four interrelated simulations. These simulations are comparable in
requirements to that provided by the AICPA and are included in the text itself. They are included in Chapters 10, 11, 12,
and 14. Three additional interrelated simulations on the text’s Web site, www.mhhe.com/whittington15e: Two of the
simulations are available to students, and all three to instructors. Because they are MS Excel based, they do not require
the extensive computer downloads necessary for the AICPA simulation.
CPA Simulation 10–50. The following simulation has three parts:
• Company proﬁle
• Industry information
• Financial statements
The company proﬁle, industry information, and ﬁnancial statements are also used as the basis for
the simulations in Chapters 11, 12, and 14. Each of those chapters has a different set of questions.
Company proﬁle: In 20X1, Gary Sherwood founded Sherwood Stone Company (SSC). In the middle of its sec-
ond year of existence, the company completed development of a large extraction pit area and
constructed an aggregate processing plant which is equipped to crush, screen, and wash ag-
gregate products. By 20X4 the sand and gravel operation was proﬁtable and growing market
conditions justiﬁed modiﬁcations and expansion. Currently, SSC produces a wide range of
sand and stone products from its pit near Bisbee, Arizona. The materials it develops are com-
posed of sand and stone materials for commercial construction and highway projects.
SSC sells to a wide variety of commercial and governmental customers, with only one of
its numerous customers—Wingo Corporation—accounting for more than 5 percent of total
sales. In total, Wingo has represented approximately 30 percent of sales (and receivables) for
the past few years. Wingo Corporation is by far Arizona’s largest street and road contractor and
Reviewers asked for multiple choice questions similar to those on the CPA exam. We have doubled the number of
this type of question in each chapter, and highlighted them in the problem material.
We have added a new chapter on integrated audits of public companies (Chapter 18) and have changed the
sequencing of the last chapters in the book.
Chapter 20 now includes coverage of internal auditing for Sarbanes-Oxley and the services that are performed by
The book is now 2-color to help highlight material in the illustrations.
We have added subtitles to the Illustrative Cases for easy reference.
We now include numbered learning objectives at the beginning of each chapter and reference them within the
Because fraud is such an important aspect of auditing today, we’ve included a logo wherever we talk about its
implications on the auditing process.
All of the text ﬁgures are now included on the Instructor’s Resource CD for easy classroom presentations.
The great volume of coverage included in the text make it ideal as the basis for not only a basic auditing course, but
also for a major portion of a second semester (or quarter) course included in either a four or ﬁve year program.
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FEATURES OF THIS EDITION
This text includes a variety of features to enhance the learning experience:
Actual business and accounting examples are used
to illustrate key chapter concepts. The cases are
boxed and appear throughout the text. New cases
have been added for recent alleged audit failures.
They are now subtitled for easy reference.
Employment with Clients
The situation in which audit clients hire audit ﬁrm personnel Andersen served as auditor, 86 employees left the ﬁrm and
is difﬁcult. On the one hand, it provides great professional accepted positions at Enron.
opportunities for individuals who enter the public account- In addition, questions arose as to the nature of the rela-
ing profession. On the other, independence concerns have tionship between continuing Arthur Andersen employees
led to the restrictions presented in this section. and those of Enron. Again, The Wall Street Journal reported
Questions were raised about the number of ex–Arthur that Arthur Andersen auditors and consultants “shared in
Andersen employees hired by Enron Corporation prior to its ofﬁce birthdays, frequented lunch-time parties in a nearby
collapse (see Chapter 1). Although both ﬁrms refused to park and participated in weekend fundraisers for charities.
disclose details, the positions and numbers of ex–Arthur They even went on Enron employees’ ski trips to Beaver
Andersen employees hired by Enron seem signiﬁcant. The Creek, Colorado.” One Enron employee suggested that
Wall Street Journal reported that Enron executives who had “People just thought they were Enron employees . . . they
previously worked with Arthur Andersen in auditing in- walked and talked the same way.” Consistently, the Wash-
cluded its chief accounting ofﬁcer, its chief ﬁnancial ofﬁcer, ington Post reported that the chief accounting ofﬁcer was
and the vice president of corporate development. The the Arthur Andersen partner’s “regular golﬁng buddy,” and
Washington Post indicated that, over the years Arthur that people at Enron referred to Andersen as “Enron Prep.”
Industry Focus Cases
These cases use examples from speciﬁc industries to
provide students with a detailed, “real world”
illustration of points being emphasized in the text.
These cases show the importance of having a
thorough knowledge of the audit client’s business
and industry. Like the illustrative cases, these cases
are boxed and appear throughout the text.
Focus on the Airline Industry
Electronic ticketing has become basic to the airline industry. Under these systems a passenger may
book a ﬂight over the telephone or by computer and be assigned a reservation number rather
than being issued a physical ticket. Since no ticket is created until the passenger checks in for the
ﬂight, the auditor is limited in the extent to which he or she can examine “paper” support for
transactions. Accordingly, audit procedures must be developed relating to the associated rev-
enues and receivables. Auditors often choose to test the computer controls in such situations.
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The use of Audit Objectives is a basic tool in audit
program design. These help the auditor focus on
the reason a procedure is being done and provide a
check to assure that all management assertions in
the ﬁnancial statements are audited.
ga o substa t ve tests o cas t a sact o s a d ba a ces.
Learning Objective 6
C. Perform Substantive Tests of Cash Transactions and Balances.
1. Obtain Analyses of Cash Balances and Reconcile to the General Ledger.
Objective: The auditors will prepare or obtain a schedule that lists all of the client’s cash accounts. For
Valuation ✓ cash in bank accounts, this schedule will typically list the bank, the account number, the
account type, and the year-end balance per books. The auditors will trace and reconcile all
accounts to the general ledger as necessary.
2. Send Standard Conﬁrmation Forms to Financial Institutions to Verify Amounts
Objectives: on Deposit.
Existence ✓ One of the objectives of the auditors’ work on cash is to substantiate the existence of the
Rights ✓ amount of cash shown on the balance sheet. A direct approach to this objective is to conﬁrm
amounts on deposit and obtain or prepare reconciliations between bank statements and the
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Illustrations, Tables, and Flowcharts
These are used throughout to enhance and clarify the presentation. In this edition, ﬂowcharts have been color-coded
consistently to help students see and better understand the concepts.
Chapter Learning Objectives
These objectives provide a concise presentation of each
chapter’s most important concepts. They are now
numbered and referenced in the chapter.
Chapter learning objectives
After studying this chapter, you should be able to:
LO1. Describe the sources and nature of cash.
LO2. Identify the auditors’ objectives for the audit of cash.
LO3. Explain the nature of the cash receipts and disbursements cycles, and describe the
fundamental controls over the business processes related to cas
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