Introduction: Professional Judgment Section 1: Client Acceptance 1.1 Ocean Manufacturing, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 The New Client Acceptance Decision Section 2: Understanding the Client's Business and Assessing Risk 2.1 Your1040Return.com . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Evaluating eBusiness Revenue Recognition, Information Privacy, and Electronic Evidence Issues 2.2 Apple Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Evaluation of Client Business Risk 2.3 Flash Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Risk Analysis 2.4 Asher Farms Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 Understanding of Client's Business Environment Section 3: Professional and Ethical Issues 3.1 A Day in the Life of Brent Dorsey . . . . . . . . . . . . . . . . . . . . . . . 57 Staff Auditor Professional Pressures 3.2 Nathan Johnson's Rental Car Reimbursement . . . . . . . . . . . . . . . . 61 Should He Pocket the Cash? 3.3 The Anonymous Caller . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Recognizing It's a Fraud and Evaluating What to Do 3.4 WorldCom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 The Story of a Whistleblower 3.5 Hollinger International . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Realities of Audit-Related Litigation Section 4: Accounting Fraud and Auditor Legal Liability 4.1 Enron Corporation and Andersen, LLP . . . . . . . . . . . . . . . . . . . 87 Analyzing the Fall of Two Giants 4.2 Comptronix Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Identifying Inherent Risk and Control Risk Factors 4.3 Cendant Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 Assessing the Control Environment and Evaluating Risk of Financial Statement Fraud 4.4 Waste Management, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 Manipulating Accounting Estimates 4.5 Xerox Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 Evaluating Risk of Financial Statement Fraud 4.6 Phar-Mor, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 Accounting Fraud, Litigation, and Auditor Liability 4.7 Satyam Computer Services Limited . . . . . . . . . . . . . . . . . . . . . 143 Controlling the Confirmation Process Section 5: Internal Control over Financial Reporting 5.1 Simply Steam, Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 Evaluation of Internal Control Environment 5.2 Easy Clean, Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 Evaluation of Internal Control Environment 5.3 Red Bluff Inn & Cafe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 Establishing Effective Internal Control in a Small Business 5.4 St. James Clothiers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169 Evaluation of Manual and IT-Based Sales Accounting System Risks 5.5 Collins Harp Enterprises . . . . . . . . . . . . . . . . . . . . . . . . . . . 177 Recommending IT Systems Development Controls 5.6 Sarbox Scooter, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181 Scoping and Evaluation Judgments in the Audit of Internal Control over Financial Reporting 5.7 Societe Generale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 How a Low-Risk Trading Area Caused a $7.2 Billion Loss Section 6: The Impact of Information Technology 6.1 Harley-Davidson, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 Identifying eBusiness Risks and Related Assurance Services for the eBusiness Marketplace 6.2 Jacksonville Jaguars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211 Evaluating IT Benefits and Risks and Identifying Trust Services Opportunities Section 7: Planning Materiality 7.1 Anne Aylor, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219 Determination of Planning Materiality and Tolerable Misstatement Section 8: Analytical Procedures 8.1 Laramie Wire Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . 233 Using Analytical Procedures in Audit Planning 8.2 Northwest Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Developing Expectations for Analytical Procedures 8.3 Burlingham Bees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243 Using Analytical Procedures as Substantive Tests Section 9: Auditing Cash, Fair Value, and Revenues 9.1 Wally's Billboard & Sign Supply . . . . . . . . . . . . . . . . . . . . . . . 249 The Audit of Cash 9.2 Henrico Retail, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265 Understanding the IT Accounting System and Identifying Audit Evidence for Retail Sales 9.3 Longeta Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269 Auditing Revenue Contracts 9.4 Bud's Big Blue Manufacturing . . . . . . . . . . . . . . . . . . . . . . . . 273 Accounts Receivable Confirmations 9.5 Morris Mining Corporation . . . . . . . . . . . . . . . . . . . . . . . . . 285 Auditing Fair Value 9.6 Hooplah, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 Applying Audit Sampling Concepts to Tests of Controls and Substantive Testing in the Revenue Cycle 9.7 RedPack Beer Company . . . . . . . . . . . . . . . . . . . . . . . . . . . 301 Estimating the Allowance for Bad Debts Section 10: Planning and Performing Audit Procedures in the Revenue and Expenditure Cycles: An Audit SImulation 10.1 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 311 Identification of Tests of Controls for the Revenue Cycle (Sales and Cash Receipts) 10.2 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 329 Identification of Substantive Tests for the Revenue Cycle (Sales and Cash Receipts) 10.3 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 339 Selection of Audit Tests and Risk Assessment for the Revenue Cycle (Sales and Cash Receipts) 10.4 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 347 Performance of Tests of Transactions for the Expenditure Cycle (Acquisitions and Cash Disbursements) 10.5 Southeast Shoe Distributor, Inc. . . . . . . . . . . . . . . . . . . . . . . 367 Performance of Tests of Balances for the Expenditure Cycle (Acquisitions and Cash Disbursements) Section 11: Developing and Evaluating Audit Documentation 11.1 The Runners Shop . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379 Litigation Support Review of Audit Documentation for Notes Payable Section 12: Completing the Audit, Reporting to Management, and External Reporting 12.1 EyeMax Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395 Evaluation of Audit Differences 12.2 Auto Parts, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 401 Considering Materiality When Evaluating Accounting Policies and Footnote Disclosures 12.3 K&K Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403 Leveraging Audit Findings to Provide Value-Added Insights in a Manufacturing Environment 12.4 Surfer Dude Duds, Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 409 Considering the Going-Concern Assumption 12.5 Murchison Technologies, Inc. . . . . . . . . . . . . . . . . . . . . . . . . 413 Evaluating an Attorney's Response and Identifying the Proper Audit Report 12.6 Going Green . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 421 Sustainability and External Reporting