Wiley CPAexcel Exam Review 2016 Study Auditing and Attestation (1) PDF

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2016 Wiley ® CPAexcel EXAM REVIEW STUDY GUIDE JANUARY 2016 AUDITING AND ATTESTATION O. Ray Whittington, CPA, PhD Cover Design: John Wiley & Sons, Inc. Cover image: © iStockphoto/turtleteeth The following items, copyright © by the American Institute of Certified Public Accountants, Inc., are rep...

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2016

Wiley ®

CPAexcel

EXAM REVIEW STUDY GUIDE JANUARY 2016

AUDITING AND ATTESTATION O. Ray Whittington, CPA, PhD

Cover Design: John Wiley & Sons, Inc. Cover image: © iStockphoto/turtleteeth 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 2014.

2.

Information for Uniform CPA Examination Candidates, Board of Examiners, 2013.

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. 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., 1993. Copyright © 2016 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, 978-750-8400, fax 978-646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at http://www.wiley.com/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 800-762-2974, outside the US at 317-572-3993 or fax 317-572-4002. 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 website at www.wiley.com ISBN 978-1-119-11996-8 (paperback); 978-1-119-25659-5 (ebk); 978-1-119-25660-1 (ebk) Printed in the United States of America 10 9 8 7 6 5 4 3 2 1

CONTENTS Preface

v

About the Author

vi

About the Contributor

vi

INTRODUCTION

1 Chapter 1: Beginning Your CPA Review Program

3

Chapter 2: Examination Grading

17

Chapter 3: Solutions Approach

19

Chapter 4: Taking the Examination

27

Chapter 5: Exam Content Overview

31

AUDITING AND ATTESTATION

39

Module 1:

Professional Responsibilities

41

Module 2:

Engagement Planning, Obtaining an Understanding of the Client and Assessing Risks

99

Module 3:

Understanding Internal Control and Assessing Control Risk

161

Module 4:

Responding to Risk Assessment: Evidence Accumulation and Evaluation

229

Module 5:

Reporting

315

Module 6:

Accounting and Review Services

413

Module 7:

Audit Sampling

447

Module 8:

Auditing with Technology

487

Module 41: Information Technology (Supplement)

505

APPENDICES

537 Appendix A: Outlines of Professional Standards

539

Appendix B: Auditing and Attestation Sample Examination

671

Appendix C: Sample Auditing and Attestation Testlet Released by AICPA

699

Appendix D: 2015 Released AICPA Questions for Auditing and Attestation

705

INDEX

725

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PREFACE Passing the CPA exam upon your first attempt is possible! The Wiley CPAexcel® Exam Review 2016 Study Guide January: Auditing and Attestation preparation materials provide you with the necessary materials (visit our website at www.wiley.com/cpa 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 50%. All Wiley CPAexcel® 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 CPAexcel® Exam Review 2016 Study Guide January: Auditing and Attestation text.

DON’T FORGET TO VISIT OUR WEBSITE AT WWW.WILEY.COM/GO/ CPAERRATA FOR SUPPLEMENTS AND UPDATES.

• The AICPA Content Specification Outlines on Auditing and Attestation for the Computerized CPA Examination beginning in 2014 • AICPA questions released in 2015 • The new task-based simulations • Coverage of new audit and attestation standards, especially • Latest AICPA auditing, ethics, and quality control standards, including the new clarity 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 authorconstructed 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 January 2016 v

ABOUT THE AUTHOR Ray Whittington, PhD, CPA, CMA, CIA, is the dean of the Driehaus College of Business 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.

ABOUT THE CONTRIBUTOR Kurt Pany, PhD, CPA, is a Professor of Accounting at Arizona State University. His basic and advanced auditing courses provided the basis on which he received the Arizona Society of CPAs’ Excellence in Teaching Award and an Arizona CPA Foundation Award for Innovation in the Classroom for the integration of computer and professional ethics applications. His professional experience includes serving for four years on the AICPA’s Auditing Standards Board, serving as an academic fellow in the Auditing Division of the AICPA, and, prior to entering academe, working as a staff auditor for Deloitte and Touche.

vi

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. Selfdiscipline is essential.

Chapter 1: Beginning Your CPA Review Program

3

Chapter 2: Examination Grading

17

Chapter 3: Solutions Approach

19

Chapter 4: Taking the Examination

27

Chapter 5: Exam Content Overview

31

1

Chapter 1: Beginning Your CPA Review Program GENERAL COMMENTS ON THE EXAMINATION The Uniform CPA Examination is delivered using computer-based testing (CBT). CBT 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. In addition, you may take the exam on your schedule, eight months of the year, 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 Examination1 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 2014. 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 mediumsized 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, 2014. 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 “taskbased simulations” are included on the Auditing and Attestation, Financial Accounting and Reporting, and Regulation exams. In addition, all simulations that test writing skills have been moved to the Business Environment and Concepts exam. New accounting and auditing pronouncements, including those in the governmental and not-for-profit areas, are tested in the testing window starting six months after the pronouncement’s effective date. If early application is permitted, a pronouncement is tested six months after the issuance date; candidates are responsible for the old pronouncement also until it is superseded. Federal laws are tested six months following their effective date. The AICPA posts content changes regularly on its Internet site at www.cpa-exam.org.

1

More information may be obtained from the AICPA’s Uniform CPA Examination Candidate Bulletin, which you can find on the AICPA’s website at www.cpa-exam.org.

3

Chapter 1: Beginning Your CPA Review Program

4

Nondisclosure and Computerization of Examination Beginning May 1996, the Uniform CPA Examination became nondisclosed. For each exam section, candidates are required to agree to a Statement of Confidentiality, which states that they will not divulge the nature and content of any exam question. The exam is computer-based, and candidates take the exam at Prometric sites in the 55 jurisdictions in which the exam is offered. The CPA exam is offered continually during the testing windows shown below. Testing Window (Exam Available)

January through February

April through May

July through August

October through November

AICPA Review and Update (Exam Unavailable)

March

June

September

December

One or more exam sections may be taken during any exam window, and the sections may be taken in any desired order. However, no candidate will be allowed to sit for the same section more than once during any given testing window. In addition, a candidate must pass all four sections of the CPA exam within a “rolling” eighteen-month period, which begins on the date he or she passes a section. In other words, you must pass the other three sections of the exam within eighteen months of when you pass the first section. If you do not pass all sections within the eighteen-month period, credit for any section(s) passed outside the eighteen-month period will expire and the section(s) must be retaken.

Types of Questions The computer-based Uniform CPA Examination consists of two basic question formats. 1. Multiple-Choice—questions requiring the selection of one of four responses to a short scenario. 2. Task-Based Simulations—short case studies that are used to assess knowledge and skills in a context approximating that found on the job through the use of realistic scenarios and tasks, and access to normally available and familiar resources. The multiple-choice questions are much like the ones that have constituted a majority of the CPA examination for years. And the good news is that these types of questions constitute about 60% of the Auditing and Attestation section.

Process for Sitting for the Examination While there are some variations in the process from state to state, the basic process for sitting for the CPA examination may be described as follows: 1. 2. 3. 4. 5. 6. 7.

Apply to take the examination (request, complete, and submit an application). Pay the examination fees Review the tutorial and sample tests Receive your Notice to Schedule (NTS) Schedule your examination(s) Take your examination(s) Receive your Score Report(s)

Applying to Take the Examination The right to practice public accounting as a CPA is governed by individual state statutes. While some rules regarding the practice of public accounting vary from jurisdiction to jurisdiction, all State Boards of Accountancy use the Uniform CPA Examination and AICPA advisory grading service as one of the requirements to practice public accounting. The State Boards of Accountancy determine the requirements to sit for the exam (e.g., education requirements). For comparisons of requirements for various state boards and those policies that are uniform across jurisdictions you should refer to the website of the National Association of State Boards of Accountancy (NASBA) at www.nasba.org. A frequent problem candidates encounter is failure to apply by the deadline. Apply to sit for the examination early. Also, you should use extreme care in filling out the application and mailing required materials to your State Board of Accountancy. If possible, have a friend review your completed application before mailing with check and other

Chapter 1: Beginning Your CPA Review Program

5

documentation. The name on your application must appear exactly the same as it appears on the identification you plan to use at the testing center. Candidates may miss a particular CPA examination window simply because of minor technical details that were overlooked (check not signed, items not enclosed, question not answered on application, etc.). Because of the very high volume of applications received in the more populous states, the administrative staff does not have time to call or write to correct minor details and will simply reject your application. The NASBA website has links to the registration information for all 55 jurisdictions. It is possible for candidates to sit for the examination at a Prometric site in any state or territory. Candidates desiring to do so should refer to the registration information for the applicable State Board of Accountancy.

International Applicants International administration of the CPA Exam is currently offered in Brazil, Japan, Bahrain, Kuwait, Lebanon, and the United Arab Emirates. If you live in one of these testing locations, or other select countries, you may be able to take the Exam without traveling to the U.S. The Exam is only offered in English, and is the same computerized test as the one administered in the U.S. You are required to meet the same eligibility requirements and complete the same licensure requirements as your U.S. counterparts. Applicants from countries other than the U.S. must follow the same basic steps as U.S. applicants. This means they must select the jurisdiction in which they wish to qualify and file an application with the board of accountancy (or its designated agent) in that jurisdiction. Any special instructions for candidates who have completed their education outside the U.S. are included in the board of accountancy requirements. For more information on the international administration of the CPA Examination, visit the International section of the NASBA website.