controls selected for testing by determining whether the company's
controls, if they are operated as prescribed by persons possessing the
necessary authority and competence to perform the control effectively,
satisfy the company's control objectives and can effectively prevent or
detect error or fraud that could result in material misstatements in
the financial statements.
    Note: A smaller, less complex company might achieve its control
objectives in a different manner from a larger, more complex
organization. For example, a smaller, less complex company might have
fewer employees in the accounting function, limiting opportunities to
segregate duties and leading the company to implement alternative
controls to achieve its control objectives. In such circumstances, the
auditor should evaluate whether those alternative controls are
effective.
    20. Procedures the auditor performs to test design effectiveness
include a mix of inquiry of appropriate personnel, observation of the
company's operations, and inspection of relevant documentation.
Walkthroughs that include these procedures ordinarily are sufficient to
evaluate design effectiveness.\101\
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    \101\ Paragraphs 37-38 of Auditing Standard No. 12 discuss
performing a walkthrough.
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Testing Operating Effectiveness
    21. The auditor should test the operating effectiveness of a
control selected for testing by determining whether the control is
operating as designed and whether the person performing the control
possesses the necessary authority and competence to perform the control
effectively.
    22. Procedures the auditor performs to test operating effectiveness
include a

mix of inquiry of appropriate personnel, observation of the company's
operations, inspection of relevant documentation, and re-performance of
the control.
Obtaining Evidence From Tests of Controls
    23. The evidence provided by the auditor's tests of the
effectiveness of controls depends upon the mix of the nature, timing,
and extent of the auditor's procedures. Further, for an individual
control, different combinations of the nature, timing, and extent of
testing might provide sufficient evidence in relation to the degree of
reliance in an audit of financial statements.
    Note: To obtain evidence about whether a control is effective, the
control must be tested directly; the effectiveness of a control cannot
be inferred from the absence of misstatements detected by substantive
procedures.
Nature of Tests of Controls
    24. Some types of tests, by their nature, produce greater evidence
of the effectiveness of controls than other tests. The following tests
that the auditor might perform are presented in the order of the
evidence that they ordinarily would produce, from least to most:
inquiry, observation, inspection of relevant documentation, and re-
performance of a control.
    Note: Inquiry alone does not provide sufficient evidence to support
a conclusion about the effectiveness of a control.
    25. The nature of the tests of controls that will provide
appropriate evidence depends, to a large degree, on the nature of the
control to be tested, including whether the operation of the control
results in documentary evidence of its operation. Documentary evidence
of the operation of some controls, such as management's philosophy and
operating style, might not exist.
    Note: A smaller, less complex company or unit might have less
formal documentation regarding the operation of its controls. In those
situations, testing controls through inquiry combined with other
procedures, such as observation of activities, inspection of less
formal documentation, or re-performance of certain controls, might
provide sufficient evidence about whether the control is effective.
Extent of Tests of Controls
    26. The more extensively a control is tested, the greater the
evidence obtained from that test.
    27. Matters that could affect the necessary extent of testing of a
control in relation to the degree of reliance on a control include the
following:
     The frequency of the performance of the control by the
company during the audit period;
     The length of time during the audit period that the
auditor is relying on the operating effectiveness of the control;
     The expected rate of deviation from a control;
     The relevance and reliability of the audit evidence to be
obtained regarding the operating effectiveness of the control;
     The extent to which audit evidence is obtained from tests
of other controls related to the assertion;
     The nature of the control, including, in particular,
whether it is a manual control or an automated control; and
     For an automated control, the effectiveness of relevant
information technology general controls.
    Note: AU sec. 350, Audit Sampling, establishes requirements
regarding the use of sampling in tests of controls.
Timing of Tests of Controls
    28. The timing of tests of controls relates to when the evidence
about the operating effectiveness of the controls is obtained and the
period of time to which it applies. Paragraph 16 of this standard
indicates that the auditor must obtain evidence that the controls
selected for testing are designed effectively and operated effectively
during the entire period of reliance.
    29. Using Audit Evidence Obtained during an Interim Period. When
the auditor obtains evidence about the operating effectiveness of
controls as of or through an interim date, he or she should determine
what additional evidence is necessary concerning the operation of the
controls for the remaining period of reliance.
    30. The additional evidence that is necessary to update the results
of testing from an interim date through the remaining period of
reliance depends on the following factors:
     The possibility that there have been any significant
changes in internal control over financial reporting subsequent to the
interim date;
    Note: If there have been significant changes to the control since
the interim date, the auditor should obtain evidence about the
effectiveness of the new or modified control;
     The inherent risk associated with the related account(s)
or assertion(s);
     The specific control tested prior to year end, including
the nature of the control and the risk that the control is no longer
effective during the remaining period, and the results of the tests of
the control;
     The planned degree of reliance on the control;
     The sufficiency of the evidence of effectiveness obtained
at an interim date; and
     The length of the remaining period.
    31. Using Audit Evidence Obtained in Past Audits. For audits of
financial statements, the auditor should obtain evidence during the
current year audit about the design and operating effectiveness of
controls upon which the auditor relies. When controls on which the
auditor plans to rely have been tested in past audits and the auditor
plans to use evidence about the effectiveness of those controls that
was obtained in prior years, the auditor should take into account the
following factors to determine the evidence needed during the current
year audit to support the auditor's control risk assessments:
     The nature and materiality of misstatements that the
control is intended to prevent or detect;
     The inherent risk associated with the related account(s)
or assertion(s);
     Whether there have been changes in the volume or nature of
transactions that might adversely affect control design or operating
effectiveness;
     Whether the account has a history of errors;
     The effectiveness of entity-level controls that the
auditor has tested, especially controls that monitor other controls;
     The nature of the controls and the frequency with which
they operate;
     The degree to which the control relies on the
effectiveness of other controls (e.g., the control environment or
information technology general controls);
     The competence of the personnel who perform the control or
monitor its performance and whether there have been changes in key
personnel who perform the control or monitor its performance;
     Whether the control relies on performance by an individual
or is automated (i.e., an automated control would generally be expected
to be lower risk if relevant information technology general controls
are effective); \102\
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    \102\ The auditor also may use a benchmarking strategy, when
appropriate, for automated application controls in subsequent years'
audits. Benchmarking is described further beginning at paragraph B28
of Auditing Standard No. 5.
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     The complexity of the control and the significance of the
judgments that must be made in connection with its operation;

     The planned degree of reliance on the control;
     The nature, timing, and extent of procedures performed in
past audits;
     The results of the previous years' testing of the control;
     Whether there have been changes in the control or the
process in which it operates since the previous audit; and
     For integrated audits, the evidence regarding the
effectiveness of the controls obtained during the audit of internal
control.
Assessing Control Risk
    32. The auditor should assess control risk for relevant assertions
by evaluating the evidence obtained from all sources, including the
auditor's testing of controls for the audit of internal control and the
audit of financial statements, misstatements detected during the
financial statement audit, and any identified control deficiencies.
    33. Control risk should be assessed at the maximum level for
relevant assertions (1) for which controls necessary to sufficiently
address the assessed risk of material misstatement in those assertions
are missing or ineffective or (2) when the auditor has not obtained
sufficient appropriate evidence to support a control risk assessment
below the maximum level.
    34. When deficiencies affecting the controls on which the auditor
intends to rely are detected, the auditor should evaluate the severity
of the deficiencies and the effect on the auditor's control risk
assessments. If the auditor plans to rely on controls relating to an
assertion but the controls that the auditor tests are ineffective
because of control deficiencies, the auditor should:
    a. Perform tests of other controls related to the same assertion as
the ineffective controls, or
    b. Revise the control risk assessment and modify the planned
substantive procedures as necessary in light of the increased
assessment of risk.
    Note: Auditing Standard No. 5 establishes requirements for
evaluating the severity of a control deficiency and communicating
identified control deficiencies to management and the audit committee
in an integrated audit. AU sec. 325, Communications About Control
Deficiencies in an Audit of Financial Statements, establishes
requirements for communicating significant deficiencies and material
weaknesses in an audit of financial statements only.
Testing Controls in an Audit of Internal Control
    35. Auditing Standard No. 5 states that the objective of the tests
of controls in an audit of internal control is to obtain evidence about
the effectiveness of controls to support the auditor's opinion on the
company's internal control over financial reporting. The auditor's
opinion relates to the effectiveness of the company's internal control
over financial reporting as of a point in time and taken as a
whole.\103\ Auditing Standard No. 5 establishes requirements regarding
the selection of controls to be tested and the necessary nature,
timing, and extent of tests of controls in an audit of internal control
over financial reporting.
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    \103\ Paragraph B1 of Auditing Standard No. 5.
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Substantive Procedures

    36. The auditor should perform substantive procedures for each
relevant assertion of each significant account and disclosure,
regardless of the assessed level of control risk.
    37. As the assessed risk of material misstatement increases, the
evidence from substantive procedures that the auditor should obtain
also increases. The evidence provided by the auditor's substantive
procedures depends upon the mix of the nature, timing, and extent of
those procedures. Further, for an individual assertion, different
combinations of the nature, timing, and extent of testing might provide
sufficient appropriate evidence to respond to the assessed risk of
material misstatement.
    38. Internal control over financial reporting has inherent
limitations,\104\ which, in turn, can affect the evidence that is
needed from substantive procedures. For example, more evidence from
substantive procedures ordinarily is needed for relevant assertions
that have a higher susceptibility to management override or to lapses
in judgment or breakdowns resulting from human failures.\105\
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    \104\ Paragraph A5 of Auditing Standard No. 5.
    \105\ See, e.g., paragraph .14 of AU sec. 328, Auditing Fair
Value Measurements and Disclosures.
---------------------------------------------------------------------------

Nature of Substantive Procedures
    39. Substantive procedures generally provide persuasive evidence
when they are designed and performed to obtain evidence that is
relevant and reliable. Also, some types of substantive procedures, by
their nature, produce more persuasive evidence than others. Inquiry
alone does not provide sufficient appropriate evidence to support a
conclusion about a relevant assertion.
    Note: Auditing Standard No. 15 discusses certain types of
substantive procedures and the relevance and reliability of audit
evidence.
    40. Taking into account the types of potential misstatements in the
relevant assertions that could result from identified risks, as
required by paragraph 9.b., can help the auditor determine the types
and combination of substantive audit procedures that are necessary to
detect material misstatements in the respective assertions.
    41. Substantive Procedures Related to the Period-end Financial
Reporting Process. The auditor's substantive procedures must include
the following audit procedures related to the period-end financial
reporting process:
    a. Reconciling the financial statements with the underlying
accounting records; and
    b. Examining material adjustments made during the course of
preparing the financial statements.
    Note: AU secs. 316.58-.62 establish requirements for examining
journal entries and other adjustments for evidence of possible material
misstatement due to fraud.
Extent of Substantive Procedures
    42. The more extensively a substantive procedure is performed, the
greater the evidence obtained from the procedure. The necessary extent
of a substantive audit procedure depends on the materiality of the
account or disclosure, the assessed risk of material misstatement, and
the necessary degree of assurance from the procedure. However,
increasing the extent of an audit procedure cannot adequately address
an assessed risk of material misstatement unless the evidence to be
obtained from the procedure is reliable and relevant.
Timing of Substantive Procedures
    43. Performing certain substantive procedures at interim dates may
permit early consideration of matters affecting the year-end financial
statements, e.g., testing material transactions involving higher risks
of misstatement. However, performing substantive procedures at an
interim date without performing procedures at a later date increases
the risk that a material misstatement could exist in the year-end
financial statements that would not be detected by the auditor. This
risk increases as the period between the interim date and year end
increases.
    44. In determining whether it is appropriate to perform substantive
procedures at an interim date, the auditor should take into account the
following:
    a. The assessed risk of material misstatement, including:

    (1) The auditor's assessment of control risk, as discussed in
paragraphs 32-34;
    (2) The existence of conditions or circumstances, if any, that
create incentives or pressures on management to misstate the financial
statements between the interim test date and the end of the period
covered by the financial statements;
    (3) The effects of known or expected changes in the company, its
environment, or its internal control over financial reporting during
the remaining period;
    b. The nature of the substantive procedures;
    c. The nature of the account or disclosure and relevant assertion;
and
    d. The ability of the auditor to perform the necessary audit
procedures to cover the remaining period.
    45. When substantive procedures are performed at an interim date,
the auditor should cover the remaining period by performing substantive
procedures, or substantive procedures combined with tests of controls,
that provide a reasonable basis for extending the audit conclusions
from the interim date to the period end. Such procedures should include
(a) comparing relevant information about the account balance at the
interim date with comparable information at the end of the period to
identify amounts that appear unusual and investigating such amounts and
(b) performing audit procedures to test the remaining period.
    46. If the auditor obtains evidence that contradicts the evidence
on which the original risk assessments were based, including evidence
of misstatements that he or she did not expect, the auditor should
revise the related risk assessments and modify the planned nature,
timing, or extent of substantive procedures covering the remaining
period as necessary. Examples of such modifications include extending
or repeating at the period end the procedures performed at the interim
date.
Dual-Purpose Tests
    47. In some situations, the auditor might perform a substantive
test of a transaction concurrently with a test of a control relevant to
that transaction (a ``dual-purpose test''). In those situations, the
auditor should design the dual-purpose test to achieve the objectives
of both the test of the control and the substantive test. Also, when
performing a dual-purpose test, the auditor should evaluate the results
of the test in forming conclusions about both the assertion and the
effectiveness of the control being tested.\106\
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    \106\ Paragraph .44 of AU sec. 350 discusses applying audit
sampling in dual-purpose tests.
---------------------------------------------------------------------------

APPENDIX A--Definitions

A1. For purposes of this standard, the terms listed below are defined
as follows:
A2. Dual-purpose test--Substantive test of a transaction and a test of
a control relevant to that transaction that are performed concurrently,
e.g., a substantive test of sales transactions performed concurrently
with a test of controls over those transactions.
A3. Period of reliance--The period being covered by the company's
financial statements, or the portion of that period, for which the
auditor plans to rely on controls in order to modify the nature,
timing, and extent of planned substantive procedures.

Auditing Standard No. 14

Evaluating Audit Results

Introduction

    1. This standard establishes requirements regarding the auditor's
evaluation of audit results and determination of whether he or she has
obtained sufficient appropriate audit evidence.

Objective

    2. The objective of the auditor is to evaluate the results of the
audit to determine whether the audit evidence obtained is sufficient
and appropriate to support the opinion to be expressed in the auditor's
report.

Evaluating the Results of the Audit of Financial Statements

    3. In forming an opinion on whether the financial statements are
presented fairly, in all material respects, in conformity with the
applicable financial reporting framework, the auditor should take into
account all relevant audit evidence, regardless of whether it appears
to corroborate or to contradict the assertions in the financial
statements.
    4. In the audit of financial statements,\107\ the auditor's
evaluation of audit results should include evaluation of the following:
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    \107\ For purposes of this standard, the term ``audit of
financial statements'' refers to the financial statement portion of
the integrated audit and to the audit of financial statements only.
---------------------------------------------------------------------------

    a. The results of analytical procedures performed in the overall
review of the financial statements (``overall review'');
    b. Misstatements accumulated during the audit, including, in
particular, uncorrected misstatements; \108\
---------------------------------------------------------------------------

    \108\ Terms defined in Appendix A, Definitions, are set in
boldface type the first time they appear.
---------------------------------------------------------------------------

    c. The qualitative aspects of the company's accounting practices;
    d. Conditions identified during the audit that relate to the
assessment of the risk of material misstatement due to fraud (``fraud
risk'');
    e. The presentation of the financial statements, including the
disclosures; and
    f. The sufficiency and appropriateness of the audit evidence
obtained.
Performing Analytical Procedures in the Overall Review
    5. In the overall review, the auditor should read the financial
statements and disclosures and perform analytical procedures to (a)
evaluate the auditor's conclusions formed regarding significant
accounts and disclosures and (b) assist in forming an opinion on
whether the financial statements as a whole are free of material
misstatement.
    6. As part of the overall review, the auditor should evaluate
whether:
    a. The evidence gathered in response to unusual or unexpected
transactions, events, amounts, or relationships previously identified
during the audit is sufficient; and
    b. Unusual or unexpected transactions, events, amounts, or
relationships \109\ indicate risks of material misstatement that were
not identified previously, including, in particular, fraud risks.
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    \109\ Paragraphs 46-48 of Auditing Standard No. 12, Identifying
and Assessing Risks of Material Misstatement and paragraph .03 of AU
sec. 329, Substantive Analytical Procedures.
---------------------------------------------------------------------------

    Note: If the auditor discovers a previously unidentified risk of
material misstatement or concludes that the evidence gathered is not
adequate, he or she should modify his or her audit procedures or
perform additional procedures as necessary in accordance with paragraph
36 of this standard.
    7. The nature and extent of the analytical procedures performed
during the overall review may be similar to the analytical procedures
performed as risk assessment procedures. The auditor should perform
analytical procedures relating to revenue through the end of the
reporting period.\110\
---------------------------------------------------------------------------

    \110\ Paragraph 47 of Auditing Standard No. 12 contains a
requirement to perform analytical procedures relating to revenue as
part of the risk assessment procedures.
---------------------------------------------------------------------------

    8. The auditor should obtain corroboration for management's
explanations regarding significant unusual or unexpected transactions,

events, amounts, or relationships. If management's responses to the
auditor's inquiries appear to be implausible, inconsistent with other
audit evidence, imprecise, or not at a sufficient level of detail to be
useful, the auditor should perform procedures to address the matter.
    9. Evaluating Whether Analytical Procedures Indicate a Previously
Unrecognized Fraud Risk. Whether an unusual or unexpected transaction,
event, amount, or relationship indicates a fraud risk, as discussed in
paragraph 6.b., depends on the relevant facts and circumstances,
including the nature of the account or relationship among the data used
in the analytical procedures. For example, certain unusual or
unexpected transactions, events, amounts, or relationships could
indicate a fraud risk if a component of the relationship involves
accounts and disclosures that management has incentives or pressures to
manipulate, e.g., significant unusual or unexpected relationships
involving revenue and income.
Accumulating and Evaluating Identified Misstatements
    10. Accumulating Identified Misstatements. The auditor should
accumulate misstatements identified during the audit, other than those
that are clearly trivial.
    Note: ``Clearly trivial'' is not another expression for ``not
material.'' Matters that are clearly trivial will be of a smaller order
of magnitude than the materiality level established in accordance with
Auditing Standard No. 11, Consideration of Materiality in Planning and
Performing an Audit, and will be inconsequential, whether taken
individually or in aggregate and whether judged by any criteria of
size, nature, or circumstances. When there is any uncertainty about
whether one or more items is clearly trivial, the matter is not
considered trivial.
    11. The auditor may designate an amount below which misstatements
are clearly trivial and do not need to be accumulated. In such cases,
the amount should be set so that any misstatements below that amount
would not be material to the financial statements, individually or in
combination with other misstatements, considering the possibility of
undetected misstatement.
    12. The auditor's accumulation of misstatements should include the
auditor's best estimate of the total misstatement in the accounts and
disclosures that he or she has tested, not just the amount of
misstatements specifically identified. This includes misstatements
related to accounting estimates, as determined in accordance with
paragraph 13 of this standard, and projected misstatements from
substantive procedures that involve audit sampling, as determined in
accordance with AU sec. 350, Audit Sampling.\111\
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    \111\ AU sec. 350.26.
---------------------------------------------------------------------------

    13. Misstatements Relating to Accounting Estimates. If the auditor
concludes that the amount of an accounting estimate included in the
financial statements is unreasonable or was not determined in
conformity with the relevant requirements of the applicable financial
reporting framework, he or she should treat the difference between that
estimate and a reasonable estimate determined in conformity with the
applicable accounting principles as a misstatement. If a range of
reasonable estimates is supported by sufficient appropriate audit
evidence and the recorded estimate is outside of the range of
reasonable estimates, the auditor should treat the difference between
the recorded accounting estimate and the closest reasonable estimate as
a misstatement.
    Note: If an accounting estimate is determined in conformity with
the relevant requirements of the applicable financial reporting
framework and the amount of the estimate is reasonable, a difference
between an estimated amount best supported by the audit evidence and
the recorded amount of the accounting estimate ordinarily would not be
considered to be a misstatement. Paragraph 27 discusses evaluating
accounting estimates for bias.
    14. Considerations as the Audit Progresses. The auditor should
determine whether the overall audit strategy and audit plan need to be
modified if:
    a. The nature of accumulated misstatements and the circumstances of
their occurrence indicate that other misstatements might exist that, in
combination with accumulated misstatements, could be material; or
    b. The aggregate of misstatements accumulated during the audit
approaches the materiality level or levels used in planning and
performing the audit.\112\
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    \112\ Auditing Standard No. 11.
---------------------------------------------------------------------------

    Note: When the aggregate of accumulated misstatements approaches
the materiality level or levels used in planning and performing the
audit, there likely will be greater than an appropriately low level of
risk that possible undetected misstatements, when combined with the
aggregate of misstatements accumulated during the audit that remain
uncorrected, could be material to the financial statements. If the
auditor's assessment of this risk is unacceptably high, he or she
should perform additional audit procedures or determine that management
has adjusted the financial statements so that the risk that the
financial statements are materially misstated has been reduced to an
appropriately low level.
    15. The auditor should communicate accumulated misstatements to
management on a timely basis to provide management with an opportunity
to correct them.
    16. If management has examined an account or a disclosure in
response to misstatements detected by the auditor and has made
corrections to the account or disclosure, the auditor should evaluate
management's work to determine whether the corrections have been
recorded properly and whether uncorrected misstatements remain.
    17. Evaluation of the Effect of Uncorrected Misstatements. The
auditor should evaluate whether uncorrected misstatements are material,
individually or in combination with other misstatements. In making this
evaluation, the auditor should evaluate the misstatements in relation
to the specific accounts and disclosures involved and to the financial
statements as a whole, taking into account relevant quantitative and
qualitative factors.\113\ (See Appendix B.)
---------------------------------------------------------------------------

    \113\ If the financial statements contain material
misstatements, AU sec. 508, Reports on Audited Financial Statements,
indicates that the auditor should issue a qualified or an adverse
opinion on the financial statements. AU sec. 508.35 discusses
situations in which the financial statements are materially affected
by a departure from the applicable financial reporting framework.
---------------------------------------------------------------------------

    Note: In interpreting the federal securities laws, the Supreme
Court of the United States has held that a fact is material if there is
``a substantial likelihood that the * * * fact would have been viewed
by the reasonable investor as having significantly altered the `total
mix' of information made available.'' \114\ As the Supreme Court has
noted, determinations of materiality require ``delicate assessments of
the inferences a `reasonable shareholder' would draw from a given set
of facts and the significance of those inferences to him * * *.'' \115\
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    \114\ TSC Industries v. Northway, Inc., 426 U.S. 438, 449
(1976). See also Basic, Inc. v. Levinson, 485 U.S. 224 (1988).
    \115\ TSC Industries, 426 U.S. at 450.
---------------------------------------------------------------------------

    Note: As a result of the interaction of quantitative and
qualitative considerations in materiality judgments, uncorrected
misstatements of relatively small amounts could have a material effect
on the financial statements. For

example, an illegal payment of an otherwise immaterial amount could be
material if there is a reasonable possibility \116\ that it could lead
to a material contingent liability or a material loss of revenue.\117\
Also, a misstatement made intentionally could be material for
qualitative reasons, even if relatively small in amount.
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    \116\ There is a reasonable possibility of an event, as used in
this standard, when the likelihood of the event is either
``reasonably possible'' or ``probable,'' as those terms are used in
the FASB Accounting Standards Codification, Contingencies Topic,
paragraph 450-20-25-1.
    \117\ AU sec. 317, Illegal Acts by Clients.
---------------------------------------------------------------------------

    Note: If the reevaluation of the established materiality level or
levels, as set forth in Auditing Standard No. 11,\118\ results in a
lower amount for the materiality level or levels, the auditor should
take into account that lower materiality level or levels in the
evaluation of uncorrected misstatements.
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    \118\ Paragraphs 11-12 of Auditing Standard No. 11.
---------------------------------------------------------------------------

    18. The auditor's evaluation of uncorrected misstatements, as
described in paragraph 17 of this standard, should include evaluation
of the effects of uncorrected misstatements detected in prior years and
misstatements detected in the current year that relate to prior years.
    19. The auditor cannot assume that an instance of error or fraud is
an isolated occurrence. Therefore, the auditor should evaluate the
nature and effects of the individual misstatements accumulated during
the audit on the assessed risks of material misstatement. This
evaluation is important in determining whether the risk assessments
remain appropriate, as discussed in paragraph 36 of this standard.
    20. Evaluating Whether Misstatements Might Be Indicative of Fraud.
The auditor should evaluate whether identified misstatements \119\
might be indicative of fraud and, in turn, how they affect the
auditor's evaluation of materiality and the related audit responses. As
indicated in AU sec. 316, Consideration of Fraud in a Financial
Statement Audit, fraud is an intentional act that results in material
misstatement of the financial statements.\120\
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    \119\ Misstatements include omission and presentation of
inaccurate or incomplete disclosures.
    \120\ AU sec. 316.05.
---------------------------------------------------------------------------

    21. If the auditor believes that a misstatement is or might be
intentional, and if the effect on the financial statements could be
material or cannot be readily determined, the auditor should perform
procedures to obtain additional audit evidence to determine whether
fraud has occurred or is likely to have occurred and, if so, its effect
on the financial statements and the auditor's report thereon.
    22. For misstatements that the auditor believes are or might be
intentional, the auditor should evaluate the implications on the
integrity of management or employees and the possible effect on other
aspects of the audit. If the misstatement involves higher-level
management, it might be indicative of a more pervasive problem, such as
an issue with the integrity of management, even if the amount of the
misstatement is small. In such circumstances, the auditor should
reevaluate the assessment of fraud risk and the effect of that
assessment on (a) the nature, timing, and extent of the necessary tests
of accounts or disclosures and (b) the assessment of the effectiveness
of controls. The auditor also should evaluate whether the circumstances
or conditions indicate possible collusion involving employees,
management, or external parties and, if so, the effect of the collusion
on the reliability of evidence obtained.
    23. If the auditor becomes aware of information indicating that
fraud or another illegal act has occurred or might have occurred, he or
she also must determine his or her responsibilities under AU secs.
316.79-.82A, AU sec. 317, and Section 10A of the Securities Exchange
Act of 1934, 15 U.S.C. Sec.  78j-1.
Evaluating the Qualitative Aspects of the Company's Accounting
Practices
    24. When evaluating whether the financial statements as a whole are
free of material misstatement, the auditor should evaluate the
qualitative aspects of the company's accounting practices, including
potential bias in management's judgments about the amounts and
disclosures in the financial statements.
    25. The following are examples of forms of management bias:
    a. The selective correction of misstatements brought to
management's attention during the audit (e.g., correcting misstatements
that have the effect of increasing reported earnings but not correcting
misstatements that have the effect of decreasing reported earnings).
    Note: To evaluate the potential effect of selective correction of
misstatements, the auditor should obtain an understanding of the
reasons that management decided not to correct misstatements
communicated by the auditor in accordance with paragraph 15.
    b. The identification by management of additional adjusting entries
that offset misstatements accumulated by the auditor. If such adjusting
entries are identified, the auditor should perform procedures to
determine why the underlying misstatements were not identified
previously and evaluate the implications on the integrity of management
and the auditor's risk assessments, including fraud risk assessments.
The auditor also should perform additional procedures as necessary to
address the risk of further undetected misstatement.
    c. Bias in the selection and application of accounting
principles.\121\
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    \121\ Paragraph 5.d. of Auditing Standard No. 13, The Auditor's
Responses to the Risks of Material Misstatement.
---------------------------------------------------------------------------

    d. Bias in accounting estimates.\122\
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    \122\ Paragraph 27 of this standard.
---------------------------------------------------------------------------

    26. If the auditor identifies bias in management's judgments about
the amounts and disclosures in the financial statements, the auditor
should evaluate whether the effect of that bias, together with the
effect of uncorrected misstatements, results in material misstatement
of the financial statements. Also, the auditor should evaluate whether
the auditor's risk assessments, including, in particular, the
assessment of fraud risks, and the related audit responses remain
appropriate.
    27. Evaluating Bias in Accounting Estimates. The auditor should
evaluate whether the difference between estimates best supported by the
audit evidence and estimates included in the financial statements,
which are individually reasonable, indicate a possible bias on the part
of the company's management. If each accounting estimate included in
the financial statements was individually reasonable but the effect of
the difference between each estimate and the estimate best supported by
the audit evidence was to increase earnings or loss, the auditor should
evaluate whether these circumstances indicate potential management bias
in the estimates. Bias also can result from the cumulative effect of
changes in multiple accounting estimates. If the estimates in the
financial statements are grouped at one end of the range of reasonable
estimates in the prior year and are grouped at the other end of the
range of reasonable estimates in the current year, the auditor should
evaluate whether management is using swings in estimates to achieve an
expected or desired outcome, e.g., to offset higher or lower than
expected earnings.

    Note: AU secs. 316.64-.65 establish requirements regarding
performing a retrospective review of accounting estimates and
evaluating the potential for fraud risks.
Evaluating Conditions Relating to the Assessment of Fraud Risks
    28. When evaluating the results of the audit, the auditor should
evaluate whether the accumulated results of auditing procedures \123\
and other observations affect the assessment of the fraud risks made
throughout the audit and whether the audit procedures need to be
modified to respond to those risks. (See Appendix C.)
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    \123\ Such auditing procedures include, but are not limited to,
procedures in the overall review (paragraph 9 of this standard), the
evaluation of identified misstatements (paragraphs 20-23 of this
standard), and the evaluation of the qualitative aspects of the
company's accounting practices (paragraphs 24-27 of this standard).
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    29. As part of this evaluation, the engagement partner should
determine whether there has been appropriate communication with the
other engagement team members throughout the audit regarding
information or conditions that are indicative of fraud risks.
    Note: To accomplish this communication, the engagement partner
might arrange another discussion among the engagement team members
about fraud risks. (See paragraphs 49-51 of Auditing Standard No. 12.)
Evaluating the Presentation of the Financial Statements, Including the
Disclosures
    30. The auditor must evaluate whether the financial statements are
presented fairly, in all material respects, in conformity with the
applicable financial reporting framework.
    Note: AU sec. 411, The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles, establishes requirements for
evaluating the presentation of the financial statements. Auditing
Standard No. 6, Evaluating Consistency of Financial Statements,
establishes requirements regarding evaluating the consistency of the
accounting principles used in financial statements.
    Note: The auditor should look to the requirements of the Securities
and Exchange Commission for the company under audit with respect to the
accounting principles applicable to that company.
    31. As part of the evaluation of the presentation of the financial
statements, the auditor should evaluate whether the financial
statements contain the information essential for a fair presentation of
the financial statements in conformity with the applicable financial
reporting framework. Evaluation of the information disclosed in the
financial statements includes consideration of the form, arrangement,
and content of the financial statements (including the accompanying
notes), encompassing matters such as the terminology used, the amount
of detail given, the classification of items in the statements, and the
bases of amounts set forth.
    Note: According to AU sec. 508, if the financial statements,
including the accompanying notes, fail to disclose information that is
required by the applicable financial reporting framework, the auditor
should express a qualified or adverse opinion and should provide the
information in the report, if practicable, unless its omission from the
report is recognized as appropriate by a specific auditing
standard.\124\
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    \124\ AU secs. 508.41-.44.
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Evaluating the Sufficiency and Appropriateness of Audit Evidence
    32. Auditing Standard No. 8, Audit Risk, states:
    To form an appropriate basis for expressing an opinion on the
financial statements, the auditor must plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement due to error or fraud. Reasonable
assurance is obtained by reducing audit risk to an appropriately low
level through applying due professional care, including obtaining
sufficient appropriate audit evidence.\125\
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    \125\ Paragraph 3 of Auditing Standard No. 8.
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    33. As part of evaluating audit results, the auditor must conclude
on whether sufficient appropriate audit evidence has been obtained to
support his or her opinion on the financial statements.
    34. Factors that are relevant to the conclusion on whether
sufficient appropriate audit evidence has been obtained include the
following:
    a. The significance of uncorrected misstatements and the likelihood
of their having a material effect, individually or in combination, on
the financial statements, considering the possibility of further
undetected misstatement (paragraphs 14 and 17-19 of this standard).
    b. The results of audit procedures performed in the audit of
financial statements, including whether the evidence obtained supports
or contradicts management's assertions and whether such audit
procedures identified specific instances of fraud (paragraphs 20-23 and
28-29 of this standard).
    c. The auditor's risk assessments (paragraph 36 of this standard).
    d. The results of audit procedures performed in the audit of
internal control over financial reporting, if the audit is an
integrated audit.
    e. The appropriateness (i.e., the relevance and reliability) of the
audit evidence obtained.\126\
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    \126\ Paragraphs 7-9 of Auditing Standard No. 15, Audit
Evidence, discuss the relevance and reliability of audit evidence.
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    35. If the auditor has not obtained sufficient appropriate audit
evidence about a relevant assertion or has substantial doubt about a
relevant assertion, the auditor should perform procedures to obtain
further audit evidence to address the matter. If the auditor is unable
to obtain sufficient appropriate audit evidence to have a reasonable
basis to conclude about whether the financial statements as a whole are
free of material misstatement, AU sec. 508 indicates that the auditor
should express a qualified opinion or a disclaimer of opinion.\127\
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    \127\ AU sec. 508.22-.34 contains requirements regarding audit
scope limitations.
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    36. Evaluating the Appropriateness of Risk Assessments. As part of
the evaluation of whether sufficient appropriate audit evidence has
been obtained, the auditor should evaluate whether the assessments of
the risks of material misstatement at the assertion level remain
appropriate and whether the audit procedures need to be modified or
additional procedures need to be performed as a result of any changes
in the risk assessments. For example, the re-evaluation of the
auditor's risk assessments could result in the identification of
relevant assertions or significant risks that were not identified
previously and for which the auditor should perform additional audit
procedures.
    Note: Auditing Standard No. 12 establishes requirements on revising
the auditor's risk assessment.\128\ Auditing Standard No. 13 discusses
the auditor's responsibilities regarding the assessment of control risk
and evaluation of control deficiencies in an audit of financial
statements.\129\
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    \128\ Paragraph 74 of Auditing Standard No. 12.
    \129\ Paragraphs 32-34 of Auditing Standard No. 13.
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Evaluating the Results of the Audit of Internal Control Over Financial
Reporting

    37. Auditing Standard No. 5, An Audit of Internal Control Over
Financial Reporting That Is Integrated with An Audit of Financial
Statements, indicates

that the auditor should form an opinion on the effectiveness of
internal control over financial reporting by evaluating evidence
obtained from all sources, including the auditor's testing of controls,
misstatements detected during the financial statement audit, and any
identified control deficiencies. Auditing Standard No. 5 describes the
auditor's responsibilities regarding evaluating the results of the
audit, including evaluating the identified control deficiencies.\130\
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    \130\ Paragraphs 62-70 of Auditing Standard No. 5 discuss
evaluating identified control deficiencies, and paragraphs 71-73 of
Auditing Standard No. 5 discuss forming an opinion on the
effectiveness of internal control over financial reporting.
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APPENDIX A--Definitions

A1. For purposes of this standard, the terms listed below are defined
as follows:
A2. Misstatement--A misstatement, if material individually or in
combination with other misstatements, causes the financial statements
not to be presented fairly in conformity with the applicable financial
reporting framework.\131\ A misstatement may relate to a difference
between the amount, classification, presentation, or disclosure of a
reported financial statement item and the amount, classification,
presentation, or disclosure that should be reported in conformity with
the applicable financial reporting framework. Misstatements can arise
from error (i.e., unintentional misstatement) or fraud.\132\
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    \131\ The auditor should look to the requirements of the
Securities and Exchange Commission for the company under audit with
respect to the accounting principles applicable to that company.
    \132\ Paragraph .02 of AU sec. 316, Consideration of Fraud in a
Financial Statement Audit.
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A3. Uncorrected misstatements--Misstatements, other than those that are
clearly trivial,\133\ that management has not corrected.
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    \133\ Paragraph 10 of this standard states that, ``[t]he auditor
should accumulate misstatements identified during the audit, other
than those that are clearly trivial.''
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APPENDIX B--Qualitative Factors Related to the Evaluation of the
Materiality of Uncorrected Misstatements

B1. Paragraph 17 of this standard states: The auditor should evaluate
whether uncorrected misstatements are material, individually or in
combination with other misstatements. In making this evaluation, the
auditor should evaluate the misstatements in relation to the specific
accounts and disclosures involved and to the financial statements as a
whole, taking into account relevant quantitative and qualitative
factors.\134\
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    \134\ If the financial statements contain material
misstatements, AU sec. 508, Reports on Audited Financial Statements,
indicates that the auditor should issue a qualified or an adverse
opinion on the financial statements. AU sec. 508.35 discusses
situations in which the financial statements are materially affected
by a departure from the applicable financial reporting framework.
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    Note: In interpreting the federal securities laws, the Supreme
Court of the United States has held that a fact is material if there is
``a substantial likelihood that the * * * fact would have been viewed
by the reasonable investor as having significantly altered the `total
mix' of information made available.'' \135\ As the Supreme Court has
noted, determinations of materiality require ``delicate assessments of
the inferences a `reasonable shareholder' would draw from a given set
of facts and the significance of those inferences to him * * * '' \136\
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    \135\ TSC Industries v. Northway, Inc., 426 U.S. 438, 449
(1976). See also Basic, Inc. v. Levinson, 485 U.S. 224 (1988).
    \136\ TSC Industries, 426 U.S. at 450.
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    Note: As a result of the interaction of quantitative and
qualitative considerations in materiality judgments, uncorrected
misstatements of relatively small amounts could have a material effect
on the financial statements. For example, an illegal payment of an
otherwise immaterial amount could be material if there is a reasonable
possibility \137\ that it could lead to a material contingent liability
or a material loss of revenue.\138\ Also, a misstatement made
intentionally could be material for qualitative reasons, even if
relatively small in amount.

    \137\ There is a reasonable possibility of an event, as used in
this standard, when the likelihood of the event is either
``reasonably possible'' or ``probable,'' as those terms are used in
the FASB Accounting Standards Codification, Contingencies Topic,
paragraph 450-20-25-1.
    \138\ AU sec. 317, Illegal Acts by Clients.

B2. Qualitative factors to consider in the auditor's evaluation of the
materiality of uncorrected misstatements, if relevant, include the
following:
    a. The potential effect of the misstatement on trends, especially
trends in profitability.
    b. A misstatement that changes a loss into income or vice versa.
    c. The effect of the misstatement on segment information, for
example, the significance of the matter to a particular segment
important to the future profitability of the company, the pervasiveness
of the matter on the segment information, and the impact of the matter
on trends in segment information, all in relation to the financial
statements taken as a whole.
    d. The potential effect of the misstatement on the company's
compliance with loan covenants, other contractual agreements, and
regulatory provisions.
    e. The existence of statutory or regulatory reporting requirements
that affect materiality thresholds.
    f. A misstatement that has the effect of increasing management's
compensation, for example, by satisfying the requirements for the award
of bonuses or other forms of incentive compensation.
    g. The sensitivity of the circumstances surrounding the
misstatement, for example, the implications of misstatements involving
fraud and possible illegal acts, violations of contractual provisions,
and conflicts of interest.
    h. The significance of the financial statement element affected by
the misstatement, for example, a misstatement affecting recurring
earnings as contrasted to one involving a non-recurring charge or
credit, such as an extraordinary item.
    i. The effects of misclassifications, for example,
misclassification between operating and non-operating income or
recurring and non-recurring income items.
    j. The significance of the misstatement or disclosures relative to
known user needs, for example:
     The significance of earnings and earnings per share to
public company investors.
     The magnifying effects of a misstatement on the
calculation of purchase price in a transfer of interests (buy/sell
agreement).
     The effect of misstatements of earnings when contrasted
with expectations.
    k. The definitive character of the misstatement, for example, the
precision of an error that is objectively determinable as contrasted
with a misstatement that unavoidably involves a degree of subjectivity
through estimation, allocation, or uncertainty.
    l. The motivation of management with respect to the misstatement,
for example, (i) an indication of a possible pattern of bias by
management when developing and accumulating accounting estimates or
(ii) a misstatement precipitated by management's continued
unwillingness to correct weaknesses in the financial reporting process.

    m. The existence of offsetting effects of individually significant
but different misstatements.
    n. The likelihood that a misstatement that is currently immaterial
may have a material effect in future periods because of a cumulative
effect, for example, that builds over several periods.
    o. The cost of making the correction--it may not be cost-beneficial
for the client to develop a system to calculate a basis to record the
effect of an immaterial misstatement. On the other hand, if management
appears to have developed a system to calculate an amount that
represents an immaterial misstatement, it may reflect a motivation of
management as noted in paragraph B2.l above.
    p. The risk that possible additional undetected misstatements would
affect the auditor's evaluation.

APPENDIX C--Matters That Might Affect the Assessment of Fraud Risks

C1. If the following matters are identified during the audit, the
auditor should take into account these matters in the evaluation of the
assessment of fraud risks, as discussed in paragraph 28 of this
standard:
    a. Discrepancies in the accounting records, including:
    (1) Transactions that are not recorded in a complete or timely
manner or are improperly recorded as to amount, accounting period,
classification, or company policy.
    (2) Unsupported or unauthorized balances or transactions.
    (3) Last-minute adjustments that significantly affect financial
results.
    (4) Evidence of employees' access to systems and records that is
inconsistent with the access that is necessary to perform their
authorized duties.
    (5) Tips or complaints to the auditor about alleged fraud.
    b. Conflicting or missing evidence, including:
    (1) Missing documents.
    (2) Documents that appear to have been altered.\139\
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    \139\ Paragraph 9 of Auditing Standard No. 15, Audit Evidence.
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    (3) Unavailability of other than photocopied or electronically
transmitted documents when documents in original form are expected to
exist.
    (4) Significant unexplained items in reconciliations.
    (5) Inconsistent, vague, or implausible responses from management
or employees arising from inquiries or analytical procedures.
    (6) Unusual discrepancies between the company's records and
confirmation responses.
    (7) Missing inventory or physical assets of significant magnitude.
    (8) Unavailable or missing electronic evidence that is inconsistent
with the company's record retention practices or policies.
    (9) Inability to produce evidence of key systems development and
program change testing and implementation activities for current year
system changes and deployments.
    (10) Unusual balance sheet changes or changes in trends or
important financial statement ratios or relationships, e.g.,
receivables growing faster than revenues.
    (11) Large numbers of credit entries and other adjustments made to
accounts receivable records.
    (12) Unexplained or inadequately explained differences between the
accounts receivable subsidiary ledger and the general ledger control
account, or between the customer statement and the accounts receivable
subsidiary ledger.
    (13) Missing or nonexistent cancelled checks in circumstances in
which cancelled checks are ordinarily returned to the company with the
bank statement.
    (14) Fewer responses to confirmation requests than anticipated or a
greater number of responses than anticipated.
    c. Problematic or unusual relationships between the auditor and
management, including:
    (1) Denial of access to records, facilities, certain employees,
customers, vendors, or others from whom audit evidence might be sought,
including:\140\
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    \140\ Denial of access to information might constitute a
limitation on the scope of the audit that requires the auditor to
qualify or disclaim an opinion. (See Auditing Standard No. 5, An
Audit of Internal Control Over Financial Reporting That Is
Integrated with An Audit of Financial Statements, and AU sec. 508,
Reports on Audited Financial Statements.)
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    a. Unwillingness to facilitate auditor access to key electronic
files for testing through the use of computer-assisted audit
techniques.
    b. Denial of access to key information technology operations staff
and facilities, including security, operations, and systems
development.
    (2) Undue time pressures imposed by management to resolve complex
or contentious issues.
    (3) Management pressure on engagement team members, particularly in
connection with the auditor's critical assessment of audit evidence or
in the resolution of potential disagreements with management.
    (4) Unusual delays by management in providing requested
information.
    (5) Management's unwillingness to add or revise disclosures in the
financial statements to make them more complete and transparent.
    (6) Management's unwillingness to appropriately address significant
deficiencies in internal control on a timely basis.
    d. Other matters, including:
    (1) Objections by management to the auditor meeting privately with
the audit committee.
    (2) Accounting policies that appear inconsistent with industry
practices that are widely recognized and prevalent.
    (3) Frequent changes in accounting estimates that do not appear to
result from changing circumstances.
    (4) Tolerance of violations of the company's code of conduct.

Auditing Standard No. 15

Audit Evidence

Introduction

    1. This standard explains what constitutes audit evidence and
establishes requirements regarding designing and performing audit
procedures to obtain sufficient appropriate audit evidence.
    2. Audit evidence is all the information, whether obtained from
audit procedures or other sources, that is used by the auditor in
arriving at the conclusions on which the auditor's opinion is based.
Audit evidence consists of both information that supports and
corroborates management's assertions regarding the financial statements
or internal control over financial reporting and information that
contradicts such assertions.

Objective

    3. The objective of the auditor is to plan and perform the audit to
obtain appropriate audit evidence that is sufficient to support the
opinion expressed in the auditor's report.\141\
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    \141\ Auditing Standard No. 14, Evaluating Audit Results,
establishes requirements regarding evaluating whether sufficient
appropriate evidence has been obtained. Auditing Standard No. 3,
Audit Documentation, establishes requirements regarding documenting
the procedures performed, evidence obtained, and conclusions reached
in an audit.

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Sufficient Appropriate Audit Evidence

    4. The auditor must plan and perform audit procedures to obtain
sufficient appropriate audit evidence to provide a reasonable basis for
his or her opinion.
    5. Sufficiency is the measure of the quantity of audit evidence.
The quantity of audit evidence needed is affected by the following:
     Risk of material misstatement (in the audit of financial
statements) or the risk associated with the control (in the audit of
internal control over financial reporting). As the risk increases, the
amount of evidence that the auditor should obtain also increases. For
example, ordinarily more evidence is needed to respond to significant
risks.\142\
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    \142\ Paragraph A5 of Auditing Standard No. 12, Identifying and
Assessing Risks of Material Misstatement.
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     Quality of the audit evidence obtained. As the quality of
the evidence increases, the need for additional corroborating evidence
decreases. Obtaining more of the same type of audit evidence, however,
cannot compensate for the poor quality of that evidence.
    6. Appropriateness is the measure of the quality of audit evidence,
i.e., its relevance and reliability. To be appropriate, audit evidence
must be both relevant and reliable in providing support for the
conclusions on which the auditor's opinion is based.
Relevance and Reliability
    7. Relevance. The relevance of audit evidence refers to its
relationship to the assertion or to the objective of the control being
tested. The relevance of audit evidence depends on:
    a. The design of the audit procedure used to test the assertion or
control, in particular whether it is designed to (1) test the assertion
or control directly and (2) test for understatement or overstatement;
and
    b. The timing of the audit procedure used to test the assertion or
control.
    8. Reliability. The reliability of evidence depends on the nature
and source of the evidence and the circumstances under which it is
obtained. For example, in general:
     Evidence obtained from a knowledgeable source that is
independent of the company is more reliable than evidence obtained only
from internal company sources.
     The reliability of information generated internally by the
company is increased when the company's controls over that information
are effective.
     Evidence obtained directly by the auditor is more reliable
than evidence obtained indirectly.
     Evidence provided by original documents is more reliable
than evidence provided by photocopies or facsimiles, or documents that
have been filmed, digitized, or otherwise converted into electronic
form, the reliability of which depends on the controls over the
conversion and maintenance of those documents.
    9. The auditor is not expected to be an expert in document
authentication. However, if conditions indicate that a document may not
be authentic or that the terms in a document have been modified but
that the modifications have not been disclosed to the auditor, the
auditor should modify the planned audit procedures or perform
additional audit procedures to respond to those conditions and should
evaluate the effect, if any, on the other aspects of the audit.
Using Information Produced by the Company
    10. When using information produced by the company as audit
evidence, the auditor should evaluate whether the information is
sufficient and appropriate for purposes of the audit by performing
procedures to: \143\
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    \143\ When using the work of a specialist engaged or employed by
management, see AU sec. 336, Using the Work of a Specialist. When
using information produced by a service organization or a service
auditor's report as audit evidence, see AU sec. 324, Service
Organizations, and for integrated audits, see Auditing Standard No.
5, An Audit of Internal Control Over Financial Reporting That Is
Integrated with An Audit of Financial Statements.
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     Test the accuracy and completeness of the information, or
test the controls over the accuracy and completeness of that
information; and
     Evaluate whether the information is sufficiently precise
and detailed for purposes of the audit.

Financial Statement Assertions

    11. In representing that the financial statements are presented
fairly in conformity with the applicable financial reporting framework,
management implicitly or explicitly makes assertions regarding the
recognition, measurement, presentation, and disclosure of the various
elements of financial statements and related disclosures. Those
assertions can be classified into the following categories:
     Existence or occurrence--Assets or liabilities of the
company exist at a given date, and recorded transactions have occurred
during a given period.
     Completeness--All transactions and accounts that should be
presented in the financial statements are so included.
     Valuation or allocation--Asset, liability, equity,
revenue, and expense components have been included in the financial
statements at appropriate amounts.
     Rights and obligations--The company holds or controls
rights to the assets, and liabilities are obligations of the company at
a given date.
     Presentation and disclosure--The components of the
financial statements are properly classified, described, and disclosed.
    12. The auditor may base his or her work on financial statement
assertions that differ from those in this standard if the assertions
are sufficient for the auditor to identify the types of potential
misstatements and to respond appropriately to the risks of material
misstatement in each significant account and disclosure that has a
reasonable possibility \144\ of containing misstatements that would
cause the financial statements to be materially misstated, individually
or in combination with other misstatements.\145\
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    \144\ There is a reasonable possibility of an event, as used in
this standard, when the likelihood of the event is either
``reasonably possible'' or ``probable,'' as those terms are used in
the FASB Accounting Standards Codification, Contingencies Topic,
paragraph 450-20-25-1.
    \145\ For an integrated audit, also see paragraph 28 of Auditing
Standard No. 5.
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Audit Procedures for Obtaining Audit Evidence

    13. Audit procedures can be classified into the following
categories:
    a. Risk assessment procedures,\146\ and
---------------------------------------------------------------------------

    \146\ Auditing Standard No. 12.
---------------------------------------------------------------------------

    b. Further audit procedures,\147\ which consist of:
---------------------------------------------------------------------------

    \147\ Auditing Standard No. 13, The Auditor's Responses to the
Risks of Material Misstatement.
---------------------------------------------------------------------------

    (1) Tests of controls, and
    (2) Substantive procedures, including tests of details and
substantive analytical procedures.
    14. Paragraphs 15-21 of this standard describe specific audit
procedures. The purpose of an audit procedure determines whether it is
a risk assessment procedure, test of controls, or substantive
procedure.
Inspection
    15. Inspection involves examining records or documents, whether
internal or external, in paper form, electronic form, or other media,
or physically examining an asset. Inspection of records and documents
provides audit evidence of varying degrees of reliability, depending on
their nature and source and, in the case of internal records and
documents, on the effectiveness of the controls over their

production. An example of inspection used as a test of controls is
inspection of records for evidence of authorization.
Observation
    16. Observation consists of looking at a process or procedure being
performed by others, e.g., the auditor's observation of inventory
counting by the company's personnel or the performance of control
activities. Observation can provide audit evidence about the
performance of a process or procedure, but the evidence is limited to
the point in time at which the observation takes place and also is
limited by the fact that the act of being observed may affect how the
process or procedure is performed.\148\
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    \148\ AU sec. 331, Inventories, establishes requirements
regarding observation of the counting of inventory.
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Inquiry
    17. Inquiry consists of seeking information from knowledgeable
persons in financial or nonfinancial roles within the company or
outside the company. Inquiry may be performed throughout the audit in
addition to other audit procedures. Inquiries may range from formal
written inquiries to informal oral inquiries. Evaluating responses to
inquiries is an integral part of the inquiry process.\149\
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    \149\ AU sec. 333, Management Representations, establishes
requirements regarding written management representations, including
confirmation of management responses to oral inquiries.
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    Note: Inquiry of company personnel, by itself, does not provide
sufficient audit evidence to reduce audit risk to an appropriately low
level for a relevant assertion or to support a conclusion about the
effectiveness of a control.
Confirmation
    18. A confirmation response represents a particular form of audit
evidence obtained by the auditor from a third party in accordance with
PCAOB standards.\150\
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    \150\ AU sec. 330, The Confirmation Process.
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Recalculation
    19. Recalculation consists of checking the mathematical accuracy of
documents or records. Recalculation may be performed manually or
electronically.
Reperformance
    20. Reperformance involves the independent execution of procedures
or controls that were originally performed by company personnel.
Analytical Procedures
    21. Analytical procedures consist of evaluations of financial
information made by a study of plausible relationships among both
financial and nonfinancial data. Analytical procedures also encompass
the investigation of significant differences from expected
amounts.\151\
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    \151\ AU sec. 329, Substantive Analytical Procedures,
establishes requirements on performing analytical procedures as
substantive procedures.
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Selecting Items for Testing to Obtain Audit Evidence

    22. Designing substantive tests of details and tests of controls
includes determining the means of selecting items for testing from
among the items included in an account or the occurrences of a control.
The auditor should determine the means of selecting items for testing
to obtain evidence that, in combination with other relevant evidence,
is sufficient to meet the objective of the audit procedure. The
alternative means of selecting items for testing are:
     Selecting all items;
     Selecting specific items; and
     Audit sampling.
    23. The particular means or combination of means of selecting items
for testing that is appropriate depends on the nature of the audit
procedure, the characteristics of the control or the items in the
account being tested, and the evidence necessary to meet the objective
of the audit procedure.
Selecting All Items
    24. Selecting all items (100 percent examination) refers to testing
the entire population of items in an account or the entire population
of occurrences of a control (or an entire stratum within one of those
populations). The following are examples of situations in which 100
percent examination might be applied:
     The population constitutes a small number of large value
items;
     The audit procedure is designed to respond to a
significant risk, and other means of selecting items for testing do not
provide sufficient appropriate audit evidence; and
     The audit procedure can be automated effectively and
applied to the entire population.
Selecting Specific Items
    25. Selecting specific items refers to testing all of the items in
a population that have a specified characteristic, such as:
     Key items. The auditor may decide to select specific items
within a population because they are important to accomplishing the
objective of the audit procedure or exhibit some other characteristic,
e.g., items that are suspicious, unusual, or particularly risk-prone or
items that have a history of error.
     All items over a certain amount. The auditor may decide to
examine items whose recorded values exceed a certain amount to verify a
large proportion of the total amount of the items included in an
account.
    26. The auditor also might select specific items to obtain an
understanding about matters such as the nature of the company or the
nature of transactions.
    27. The application of audit procedures to items that are selected
as described in paragraphs 25-26 of this standard does not constitute
audit sampling, and the results of those audit procedures cannot be
projected to the entire population.\152\
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    \152\ If misstatements are identified in the selected items, see
paragraphs 12-13 and paragraphs 17-19 of Auditing Standard No. 14.
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Audit Sampling
    28. Audit sampling is the application of an audit procedure to less
than 100 percent of the items within an account balance or class of
transactions for the purpose of evaluating some characteristic of the
balance or class.\153\
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    \153\ AU sec. 350, Audit Sampling, establishes requirements
regarding audit sampling.
---------------------------------------------------------------------------

Inconsistency in, or Doubts about the Reliability of, Audit Evidence

    29. If audit evidence obtained from one source is inconsistent with
that obtained from another, or if the auditor has doubts about the
reliability of information to be used as audit evidence, the auditor
should perform the audit procedures necessary to resolve the matter and
should determine the effect, if any, on other aspects of the audit.
Conforming Amendment to PCAOB Interim Quality Control Standards

Auditing Standards

    AU sec. 110, ``Responsibilities and Functions of the Independent
Auditor''
    Statement on Auditing Standards (``SAS'') No. 1, ``Codification of
Auditing Standards and Procedures'' section 110, ``Responsibilities and
Functions of the Independent Auditor'' (AU sec. 110, ``Responsibilities
and Functions of the Independent Auditor''), as amended, is amended as
follows: Within footnote 1 to paragraph .02, the reference to section
312, Audit Risk and Materiality in Conducting an Audit, is replaced
with a reference to Auditing Standard No. 11, Consideration of
Materiality in Planning and Performing an Audit.
    AU sec. 150, ``Generally Accepted Auditing Standards''

    SAS No. 95, ``Generally Accepted Auditing Standards'' (AU sec. 150,
``Generally Accepted Auditing Standards''), as amended, is amended as
follows:
    a. Within paragraph .02, in the third standard of field work, the
word ``competent'' is replaced with the word ``appropriate.''
    b. Footnote 2 to paragraph .04 is deleted.
    AU sec. 210, ``Training and Proficiency of the Independent
Auditor''
    SAS No. 1, ``Codification of Auditing Standards and Procedures''
section 210, ``Training and Proficiency of the Independent Auditor''
(AU sec. 210, ``Training and Proficiency of the Independent Auditor''),
as amended, is amended as follows:
    The last sentence of paragraph .03 is replaced with: The engagement
partner must exercise seasoned judgment in the varying degrees of his
supervision and review of the work done and judgments exercised by his
subordinates, who in turn must meet the responsibilities attaching to
the varying gradations and functions of their work.
    AU sec. 230, ``Due Professional Care in the Performance of Work''
    SAS No. 1, ``Codification of Auditing Standards and Procedures''
section 230, ``Due Professional Care in the Performance of Work'' (AU
sec. 230, ``Due Professional Care in the Performance of Work''), as
amended, is amended as follows:
    a. The second and third sentences of paragraph .06 are replaced
with: The engagement partner should know, at a minimum, the relevant
professional accounting and auditing standards and should be
knowledgeable about the client. The engagement partner is responsible
for the assignment of tasks to, and supervision of, the members of the
engagement team.\fn4\
    b. Footnote 3 to paragraph .06 is deleted.
    c. Within footnote 4 to paragraph .06, the phrase ``See section
311.11'' is replaced with, ``See Auditing Standard No. 10, Supervision
of the Audit Engagement.''
    d. Footnote 6 to paragraph .11 is deleted.
    e. In the first sentence of paragraph .11, the word ``competent''
is replaced with the word ``appropriate.''
    f. At the end of the fifth sentence of paragraph .12, the following
parenthetical is added: ``(See paragraph 9 of Auditing Standard No. 15,
Audit Evidence.)''
    AU sec. 310, ``Appointment of the Independent Auditor''
    SAS No. 1, ``Codification of Auditing Standards and Procedures''
section 310, ``Appointment of the Independent Auditor'' (AU sec. 310,
``Appointment of the Independent Auditor''), as amended, is amended as
follows:
    a. Within footnote ** to the title of the standard, the sentence
``(See section 313.)'' is deleted.
    b. Paragraph .02 is replaced with: Audit planning is discussed in
Auditing Standard No. 9, Audit Planning, and supervision of engagement
team members is discussed in Auditing Standard No. 10, Supervision of
the Audit Engagement.
    c. In paragraph .03, the sentence ``(See section 313)'' is deleted.
    d. Within footnote 3 to paragraph .06, the reference to Section
312, Audit Risk and Materiality in Conducting an Audit, paragraph .04,
is replaced with a reference to Paragraph A2 of Auditing Standard No.
14, Evaluating Audit Results.
    AU sec. 311, ``Planning and Supervision''
    SAS No. 22, ``Planning and Supervision'' (AU sec. 311, ``Planning
and Supervision''), as amended, is superseded.
    AU sec. 9311, ``Planning and Supervision: Auditing Interpretations
of Section 311''
    AU sec. 9311, ``Planning and Supervision: Auditing Interpretations
of Section 311'', as amended, is superseded.
    AU sec. 312, ``Audit Risk and Materiality in Conducting an Audit''
    SAS No. 47, ``Audit Risk and Materiality in Conducting an Audit''
(AU sec. 312, ``Audit Risk and Materiality in Conducting an Audit''),
as amended, is superseded.
    AU sec. 9312, ``Audit Risk and Materiality in Conducting an Audit:
Auditing Interpretations of Section 312''
    AU sec. 9312, ``Audit Risk and Materiality in Conducting an Audit:
Auditing Interpretations of Section 312'' is superseded.
    AU sec. 313, ``Substantive Tests Prior to the Balance Sheet Date''
    SAS No. 45, ``Omnibus Statement on Auditing Standards--1983'' (AU
sec. 313, ``Substantive Tests Prior to the Balance Sheet Date''), as
amended, is superseded.
    AU sec. 315, ``Communications Between Predecessor and Successor
Auditors''
    SAS No. 84, ``Communications Between Predecessor and Successor
Auditors'' (AU sec. 315, ``Communications Between Predecessor and
Successor Auditors''), as amended, is amended as follows:
    a. In the first sentence of paragraph .12, the word ``competent''
is replaced with the word ``appropriate.''
    b. In the first sentence of paragraph .18, the word ``competent''
is replaced with the word ``appropriate.''
    AU sec. 316, ``Consideration of Fraud in a Financial Statement
Audit''
    SAS No. 99, ``Consideration of Fraud in a Financial Statement
Audit'' (AU sec. 316, ``Consideration of Fraud in a Financial Statement
Audit''), as amended, is amended as follows:
    a. The second sentence of paragraph .01 is replaced with: This
section establishes requirements and provides direction relevant to
fulfilling that responsibility, as it relates to fraud, in an audit of
financial statements.\fn2\
    b. In footnote 1 to paragraph .01, delete the following
information: (see section 312, Audit Risk and Materiality in Conducting
an Audit,'' and the closing parenthesis at the end of that sentence.
    c. Footnote 2 to paragraph .01 is replaced with: For purposes of
this standard, the term ``audit of financial statements'' refers to the
financial statement portion of the integrated audit and to the audit of
financial statements only.
    d. The following paragraph .01A is added: Auditing Standard No. 12,
Identifying and Assessing Risks of Material Misstatement, establishes
requirements regarding the process of identifying and assessing risks
of material misstatement of the financial statements. Auditing Standard
No. 13, The Auditor's Responses to the Risks of Material Misstatement,
establishes requirements regarding designing and implementing
appropriate responses to the risks of material misstatement. Auditing
Standard No. 14, Evaluating Audit Results, establishes requirements
regarding the auditor's evaluation of audit results and determination
of whether he or she has obtained sufficient appropriate audit
evidence.
    e. In paragraph .02:
     The third through the sixth bullet points are deleted.
     The seventh bullet point is replaced with: Responding to
fraud risks
    This section discusses certain responses to fraud risks involving
the nature, timing, and extent of audit procedures, including:
    [cir] Responses to assessed fraud risks relating to fraudulent
financial reporting and misappropriation of assets (see paragraphs .52
through .56).
    [cir] Responses to specifically address the fraud risks arising
from management override of internal controls (see paragraphs .57
through .67).
     The eighth bullet point is deleted.
    f. Paragraph .03 is deleted.
    g. Footnote 5 to paragraph .06 is replaced with: The auditor should
look

to the requirements of the Securities and Exchange Commission for the
company under audit with respect to accounting principles applicable to
that company.
    h. In the third sentence of paragraph .13, the term ``the risk of
material misstatement due to fraud'' is replaced with the term ``fraud
risks.''
    i. Paragraphs .14 through .45 are deleted, along with the preceding
heading, ``Discussion Among Engagement Personnel Regarding the Risks of
Material Misstatement Due to Fraud.''
    j. Footnotes 8 through 19 related to paragraphs .14 through .45 are
deleted.
    k. Paragraphs .46 through .50 are deleted. The heading preceding
paragraph .46, ``Responding to the Results of the Assessment,'' is
replaced with the heading ``Responding to Assessed Fraud Risks.''
    l. Paragraph .51 is deleted. The heading preceding paragraph .51,
``Responses Involving the Nature, Timing, and Extent of Procedures to
Be Performed to Address the Identified Risks,'' is replaced with the
heading ``Responses Involving the Nature, Timing, and Extent of
Procedures to Be Performed.''
    m. Paragraph .52 is replaced with: Paragraph 8 of Auditing Standard
No. 13, The Auditor's Responses to the Risks of Material Misstatement,
states that ``[t]he auditor should design and perform audit procedures
in a manner that addresses the assessed risks of material misstatement
due to error or fraud for each relevant assertion of each significant
account and disclosure.'' Paragraph 12 of Auditing Standard No. 13
states that ``the audit procedures that are necessary to address the
assessed fraud risks depend upon the types of risks and the relevant
assertions that might be affected.''
    Note: Paragraph 71.b. of Auditing Standard No. 12, Identifying and
Assessing Risks of Material Misstatement, states that a fraud risk is a
significant risk. Accordingly, the requirement for responding to
significant risks also applies to fraud risks.
    n. In paragraph .53:
     The first sentence is replaced with: The following are
examples of responses to assessed fraud risks involving the nature,
timing, and extent of audit procedures:
     The fifth bullet point is replaced with: Interviewing
personnel involved in activities in areas in which a fraud risk has
been identified to obtain their insights about the risk and how
controls address the risk. (See paragraph 54 of Auditing Standard No.
12, Identifying and Assessing Risks of Material Misstatement)
     In the sixth bullet point, the term ``risk of material
misstatement due to fraud'' is replaced with the term ``fraud risk.''
    o. Footnote 20 to paragraph .53 is replaced with: AU sec. 329,
Substantive Analytical Procedures, establishes requirements regarding
performing analytical procedures as substantive tests.
    p. The heading preceding paragraph .54, ``Additional Examples of
Responses to Identified Risks of Misstatements Arising From Fraudulent
Financial Reporting,'' is replaced with the heading ``Additional
Examples of Audit Procedures Performed to Respond to Assessed Fraud
Risks Relating to Fraudulent Financial Reporting.''
    q. The first sentence in paragraph .54 is replaced with: The
following are additional examples of audit procedures that might be
performed in response to assessed fraud risks relating to fraudulent
financial reporting:
    r. In paragraph .54:
     In the last sentence of the first bullet point, the term
``risk of material misstatement due to fraud'' is replaced with the
term ``fraud risk.''
     In the first sentence of the second bullet point, the term
``risk of material misstatement due to fraud'' is replaced with the
term ``fraud risk.''
     In the first sentence of the third bullet point and the
accompanying paragraph to the third bullet point, the term ``risk of
material misstatement due to fraud'' is replaced with the term ``fraud
risk.''
    s. Footnotes 21 and 22 to paragraph .54 are amended as follows:
     The text of footnote 21 is replaced with ``AU sec. 330,
The Confirmation Process, establishes requirements regarding the
confirmation process in audits of financial statements.''
     The text of footnote 22 is replaced with ``AU sec. 336,
Using the Work of a Specialist, establishes requirements for an auditor
who uses the work of a specialist in performing an audit of financial
statements.''
    t. The heading preceding paragraph .55, ``Examples of Responses to
Identified Risks of Misstatements Arising From Misappropriations of
Assets,'' is replaced with the heading ``Examples of Audit Procedures
Performed to Respond to Fraud Risks Relating to Misappropriations of
Assets.''
    u. In the first sentence of paragraph .55, the term ``risk of
material misstatement due to fraud'' is replaced with the term ``fraud
risk.''
    v. In paragraph .56:
     The first and second sentences are replaced with: The
audit procedures performed in response to a fraud risk relating to
misappropriation of assets usually will be directed toward certain
account balances. Although some of the audit procedures noted in
paragraphs .53 and .54 and in paragraphs 8 through 15 of Auditing
Standard No. 13, The Auditor's Responses to the Risks of Material
Misstatement, may apply in such circumstances, such as the procedures
directed at inventory quantities, the scope of the work should be
linked to the specific information about the misappropriation risk that
has been identified.
     In the third sentence, the words ``design and'' are added
before the words ``operating effectiveness.''
    w. The heading preceding paragraph .57, ``Responses to Further
Address the Risk of Management Override of Controls,'' is replaced with
the heading ``Audit Procedures Performed to Specifically Address the
Risk of Management Override of Controls.''
    x. The third sentence of paragraph .57 is replaced with:
Accordingly, as part of the auditor's responses that address fraud
risks, the procedures described in paragraphs .58 through .67 should be
performed to specifically address the risk of management override of
controls.
    y. Footnote 23 to paragraph .58 is replaced with: See paragraphs 28
through 32 of Auditing Standard No. 12, Identifying and Assessing Risks
of Material Misstatement.
    z. In paragraph .61:
     In the first sentence of the first bullet point, the term
``the risk of material misstatement due to fraud'' is replaced with the
term ``fraud risk.''
     In the second bullet point, the last two sentences are
replaced with the following: Effective controls over the preparation
and posting of journal entries and adjustments may affect the extent of
substantive testing necessary, provided that the auditor has tested the
controls. However, even though controls might be implemented and
operating effectively, the auditor's substantive procedures for testing
journal entries and other adjustments should include the identification
and substantive testing of specific items.
     In item (f) of the fifth bullet point, the term ``risk of
material misstatement due to fraud'' is replaced with the term ``fraud
risk.''
     The last sentence of the fifth bullet point is replaced
with: In audits of entities that have multiple locations or business
units, the auditor should determine whether to select journal entries
from locations based on factors set forth in paragraphs 11 through 14
of

Auditing Standard No. 9, Audit Planning.
    aa. The last sentence of paragraph .63 is replaced with: Paragraphs
24 through 27 of Auditing Standard No. 14, Evaluating Audit Results,
discuss the auditor's responsibilities for assessing bias in accounting
estimates and the effect of bias on the financial statements.
    bb. Paragraphs .68 through .78 are deleted, along with the
preceding heading ``Evaluating Audit Evidence.''
    cc. Footnotes 26 through 36 related to paragraphs .68 through .78
are deleted.
    dd. In the first sentence of paragraph .80, the term ``risks of
material misstatement due to fraud'' is replaced with the term ``fraud
risks.''
    ee. The last sentence of paragraph .80 is replaced with: The
auditor also should evaluate whether the absence of or deficiencies in
controls that address fraud risks or otherwise help prevent, deter, and
detect fraud (see paragraphs 72-73 of Auditing Standard No. 12,
Identifying and Assessing Risks of Material Misstatement) represent
significant deficiencies or material weaknesses that should be
communicated to senior management and the audit committee.
    ff. The first sentence of paragraph .81 is replaced with: The
auditor also should consider communicating other fraud risks, if any,
identified by the auditor.
    gg. In paragraph .83:
     The reference in the first bullet point to paragraphs .14
through .17 is replaced with a reference to paragraphs 52 and 53 of
Auditing Standard No. 12, Identifying and Assessing Risks of Material
Misstatement.
     The term ``risks of material misstatement due to fraud''
in the first sentence of the second bullet point is replaced with the
term ``fraud risks.'' The reference in the second bullet point to
paragraphs .19 through .34 is replaced with references to paragraph 47,
paragraphs 56 through 58, and paragraphs 65 through 69 of Auditing
Standard No. 12, Identifying and Assessing Risks of Material
Misstatement.
     The third bullet point is replaced with: The fraud risks
that were identified at the financial statement and assertion levels
(see paragraphs 59 through 69 of Auditing Standard No. 12, Identifying
and Assessing Risks of Material Misstatement), and the linkage of those
risks to the auditor's response (see paragraphs 5 through 15 of
Auditing Standard No. 13, The Auditor's Responses to the Risks of
Material Misstatement).
     Within the fourth bullet point, the term ``risk of
material misstatement due to fraud'' in the first sentence is replaced
with the term ``fraud risk,'' and the reference to paragraph .41 is
replaced with a reference to paragraph 68 of Auditing Standard No. 12,
Identifying and Assessing Risks of Material Misstatement.
     The fifth bullet point is replaced with: The results of
the procedures performed to address the assessed fraud risks, including
those procedures performed to further address the risk of management
override of controls (See paragraph 15 of Auditing Standard No. 13, The
Auditor's Responses to the Risks of Material Misstatements.)
     The reference in the sixth bullet point to paragraphs .68
through .73 is replaced with a reference to paragraphs 5 through 9 of
Auditing Standard No. 14, Evaluating Audit Results.
    hh. Paragraph .84 and the heading preceding this paragraph,
``Effective Date,'' are deleted.
    ii. The first sentence of paragraph .85 is replaced with: This
appendix contains examples of risk factors discussed in paragraphs 65
through 69 of Auditing Standard No. 12, Identifying and Assessing Risks
of Material Misstatement.
    AU sec. 317, ``Illegal Acts by Clients''
    SAS No. 54, ``Illegal Acts by Clients'' (AU sec. 317, ``Illegal
Acts by Clients'') is amended as follows:
    a. The last sentence of paragraph .13 is replaced with: For
example, an illegal payment of an otherwise immaterial amount could be
material if there is a reasonable possibility that it could lead to a
material contingent liability or a material loss of revenue.
    b. In paragraph .19, the word ``competent'' is replaced with the
word ``appropriate.''
    AU sec. 319, ``Consideration of Internal Control in a Financial
Statement Audit''
    SAS No. 55, ``Consideration of Internal Control in a Financial
Statement Audit'' (AU sec. 319, ``Consideration of Internal Control in
a Financial Statement Audit''), as amended, is superseded.
    AU sec. 322, ``The Auditor's Consideration of the Internal Audit
Function in an Audit of Financial Statements''
    SAS No. 65, ``The Auditor's Consideration of the Internal Audit
Function in an Audit of Financial Statements'' (AU sec. 322, ``The
Auditor's Consideration of the Internal Audit Function in an Audit of
Financial Statements''), as amended, is amended as follows:
    a. In the first sentence of paragraph .02, the word ``competent''
is replaced with the word ``appropriate.''
    b. Footnote 3 to paragraph .04, is replaced with: Auditing Standard
No. 12, Identifying and Assessing Risks of Material Misstatement,
describes the procedures the auditor performs to obtain an
understanding of internal control over financial reporting.
    c. In the first sentence of paragraph .18, the word ``competent''
is replaced with the word ``appropriate.''
    d. Within footnote 5 to paragraph .18, the reference to section
326, Evidential Matter, paragraph .19c. is replaced with a reference to
paragraph 8 of Auditing Standard No. 15, Audit Evidence.
    e. Within footnote 8 to paragraph .27, the reference to section
311, Planning and Supervision, paragraphs .11 through .14 is replaced
with a reference to Auditing Standard No. 10, Supervision of the Audit
Engagement.
    AU sec. 324, ``Service Organizations''
    SAS No. 70, ``Service Organizations'' (AU sec. 324, ``Service
Organizations''), as amended, is amended as follows:
    a. In the first sentence of paragraph .07, the reference to Section
319, Consideration of Internal Control in a Financial Statement Audit,
is replaced with a reference to Auditing Standard No. 12, Identifying
and Assessing Risks of Material Misstatement.
    b. In the first sentence of paragraph .16, the reference to section
319.90 through .99 is replaced with a reference to paragraph 18 and
paragraphs 29 through 31 of Auditing Standard No. 13, The Auditor's
Responses to the Risks of Material Misstatement.
    c. In the second sentence of paragraph .23, the reference to
section 312, Audit Risk and Materiality in Conducting an Audit, is
replaced with a reference to Auditing Standard No. 14, Evaluating Audit
Results.
    AU sec. 326, ``Evidential Matter''
    SAS No. 31, ``Evidential Matter'' (AU sec. 326, ``Evidential
Matter''), as amended, is superseded.
    AU sec. 9326, ``Evidential Matter: Auditing Interpretations of
Section 326''
    AU sec. 9326, ``Evidential Matter: Auditing Interpretations of
Section 326,'' as amended, is amended as follows:
    a. Paragraphs .01-.05 are deleted, along with the preceding heading
``1. Evidential Matter for an Audit of Interim Financial Statements.''
    b. The reference in paragraph .10 to Section 326, Evidential
Matter, paragraph .25, is replaced with a reference to Paragraph 35 of
Auditing Standard No. 14, Evaluating Audit Results.
    c. In the first and second sentences of paragraph .10, the word
``competent'' is replaced with the word ``appropriate.''

    d. In the second sentence of paragraph .12, the word ``competent''
is replaced with the word ``appropriate.''
    e. The last two sentences of paragraph .12 are deleted.
    f. In the first sentence of paragraph .13, the word ``competent''
is replaced with the word ``appropriate.''
    g. In paragraph .17, the word ``competent'' is replaced with the
word ``appropriate.''
    h. In the second sentence of paragraph .21, the word ``competent''
is replaced with the word ``appropriate.''
    i. In the fourth sentence of paragraph .22, the word ``competent''
is replaced with the word ``appropriate.''
    j. In paragraph .23, the word ``competent'' is replaced with the
word ``appropriate.''
    k. Paragraphs .24-.41 are deleted, along with the headings ``3. The
Auditor's Consideration of the Completeness Assertion'' and ``4.
Applying Auditing Procedures to Segment Disclosures in Financial
Statements.''
    AU sec. 328, ``Auditing Fair Value Measurements and Disclosures''
    SAS No. 101, ``Auditing Fair Value Measurements and Disclosures''
(AU sec. 328, ``Auditing Fair Value Measurements and Disclosures''), as
amended, is amended as follows:
    a. In the first sentence of paragraph .03, the word ``competent''
is replaced with the word ``appropriate.''
    b. The phrase in paragraph .11 ``Section 319, Consideration of
Internal Control in a Financial Statement Audit, as amended,'' is
replaced with ``Auditing Standard No. 12, Identifying and Assessing
Risks of Material Misstatement,''
    c. The reference in paragraph .14 to Section 319 is replaced with a
reference to Paragraph A5, second note of Auditing Standard No. 5, An
Audit of Internal Control Over Financial Reporting That Is Integrated
with An Audit of Financial Statements.
    d. In the second sentence of paragraph .14, the reference ``(see
section 316, Consideration of Fraud in a Financial Statement Audit'' is
deleted.
    e. Within paragraph .25, in the second sentence of the second
bullet point and in the first sentence in the third bullet point, the
word ``competent'' is replaced with the word ``appropriate.''
    f. In the second sentence of paragraph .32, the word ``competent''
is replaced with the word ``appropriate.''
    g. In the first sentence of paragraph .42, the word ``competent''
is replaced with the word ``appropriate.''
    h. In footnote 8 to paragraph .43, the reference to section 431,
Adequacy of Disclosure in Financial Statements, is replaced with a
reference to ``paragraph 31 of Auditing Standard No. 14, Evaluating
Audit Results.''
    i. In the second sentence of paragraph .44, the word ``competent''
is replaced with the word ``appropriate.''
    j. The reference in paragraph .47 to section 312, Audit Risk and
Materiality in Conducting an Audit, paragraphs .36 through .41, is
replaced with a reference to paragraphs 12 through 18 and 24 through 27
of Auditing Standard No. 14, Evaluating Audit Results.
    AU sec. 329, ``Analytical Procedures''
    SAS No. 56, ``Analytical Procedures'' (AU sec. 329, ``Analytical
Procedures''), as amended, is amended as follows:
    a. The title of the standard, ``Analytical Procedures,'' is
replaced with the title, ``Substantive Analytical Procedures.''
    b. The text of paragraph .01 is replaced with: This section
establishes requirements regarding the use of substantive analytical
procedures in an audit.
    Note: Auditing Standard No. 12, Identifying and Assessing Risks of
Material Misstatement, establishes requirements regarding performing
analytical procedures as a risk assessment procedure in identifying and
assessing risks of material misstatement.
    Note: Auditing Standard No. 14, Evaluating Audit Results,
establishes requirements regarding performing analytical procedures as
part of the overall review stage of the audit.
    c. The last sentence of paragraph .03 is deleted.
    d. The text of paragraph .04 is replaced with: Analytical
procedures are used as a substantive test to obtain evidential matter
about particular assertions related to account balances or classes of
transactions. In some cases, analytical procedures can be more
effective or efficient than tests of details for achieving particular
substantive testing objectives.
    e. Paragraphs .06-.08 and the preceding heading, ``Analytical
Procedures in Planning the Audit,'' are deleted.
    f. At the end of paragraph .09, the following new sentence is
added: (See paragraph 11 of Auditing Standard No. 13, The Auditor's
Responses to the Risks of Material Misstatement.)
    g. Within footnote 1 to paragraph .09, the reference to section
326, Evidential Matter, is replaced with a reference to Auditing
Standard No. 15, Audit Evidence.
    h. Footnote 2 to paragraph .20 is deleted.
    i. In paragraph .21:
     In the fourth sentence, the word ``likely'' is deleted.
     The reference to section 316, Consideration of Fraud in a
Financial Statement Audit, is replaced with a reference to Auditing
Standard No. 14, Evaluating Audit Results.
    j. Footnote 3 to paragraph .21 is deleted.
    k. Paragraph .23 and the preceding heading, ``Analytical Procedures
Used in the Overall Review,'' and paragraph .24 and the preceding
heading, ``Effective Date,'' are deleted.
    AU sec. 330, ``The Confirmation Process''
    SAS No. 67, ``The Confirmation Process'' (AU sec. 330, ``The
Confirmation Process''), is amended as follows:
    a. The references in paragraph .02 to section 312, Audit Risk and
Materiality in Conducting an Audit, and section 313, Substantive Tests
Prior to the Balance-Sheet Date, are replaced with a reference to
Auditing Standard No. 13, The Auditor's Responses to the Risks of
Material Misstatement.
    b. The reference in paragraph .05 to Section 312 is replaced with a
reference to Auditing Standard No. 8, Audit Risk.
    c. The second sentence of paragraph .06 is replaced with: See
paragraph 8 of Auditing Standard No. 15, Audit Evidence, which
discusses the reliability of audit evidence.
    d. In the first sentence of paragraph .11, the word ``competent''
is replaced with the word ``appropriate.''
    e. In the third sentence of paragraph .11, the reference to Section
326 is replaced with a reference to Auditing Standard No. 15, Audit
Evidence.
    f. In the first sentence of paragraph .24, the word ``competence''
is replaced with the word ``appropriateness.''
    g. In the last sentence of paragraph .27, the word ``competent'' is
replaced with the word ``appropriate.''
    AU sec. 332, ``Auditing Derivative Instruments, Hedging Activities,
and Investments in Securities''
    SAS No. 92, ``Auditing Derivative Instruments, Hedging Activities,
and Investment in Securities'' (AU sec. 332, ``Auditing Derivative
Instruments, Hedging Activities, and Investments in Securities''), as
amended, is amended as follows:
    a. The reference in paragraph .01 to section 326, Evidential
Matter, paragraphs .03-.08, is replaced with a reference to paragraphs
11 and 12 of Auditing Standard No. 15, Audit Evidence.
    b. Paragraph .06 is replaced with: Auditing Standard No. 9, Audit
Planning, discusses the auditor's responsibilities for consideration of
the use of persons with specialized skill or knowledge. Auditing
Standard No. 10,

Supervision of the Audit Engagement, discusses the auditor's
responsibilities for supervision of specialists who are employed by the
auditor. AU sec. 336, Using the Work of a Specialist, discusses the
auditor's responsibilities for using the work of a specialist engaged
by the auditor.
    c. The first and second sentences of paragraph .07 are deleted. The
third sentence is replaced with:
    The auditor should design and perform audit procedures regarding
relevant assertions of derivatives and investments in securities that
are based on and that address the risks of material misstatement in
those assertions.
    d. The reference in paragraph .09 to Section 319, Consideration of
Internal Control in a Financial Statement Audit, is replaced with a
reference to Auditing Standard No. 12, Identifying and Assessing Risks
of Material Misstatement.
    e. The fourth sentence of paragraph .11 is replaced with
``Paragraphs 28 through 32 and B1 through B6 of Auditing Standard No.
12, Identifying and Assessing Risks of Material Misstatement, discuss
the information system, including related business processes, relevant
to financial reporting.''
    f. In paragraph .15, the reference to section 319 is replaced with
a reference to Auditing Standard No. 12, Identifying and Assessing
Risks of Material Misstatement.
    g. The last sentence of paragraph .35 is replaced with: In
addition, paragraphs 24 through 27 of Auditing Standard No. 14,
Evaluating Audit Results, describe the auditor's responsibilities for
assessing bias in accounting estimates.
    h. In paragraph .43, subparagraph a., the word ``competent'' is
replaced with the word ``appropriate.''
    i. In paragraph .51, the last sentence is replaced with: (See
paragraph 31 of Auditing Standard No. 14, Evaluating Audit Results.)
    j. In paragraph .57, subparagraph c., the word ``competent'' is
replaced with the word ``appropriate.''
    AU sec. 333, ``Management Representations''
    SAS No. 85, ``Management Representations'' (AU sec. 333,
``Management Representations''), as amended, is amended as follows:
    a. Footnote 4 to paragraph .06 is replaced with: Auditing Standard
No. 14, Evaluating Audit Results, indicates that a misstatement can
arise from error or fraud and also discusses the auditor's
responsibilities for evaluating accumulated misstatements.
    b. Within footnote 6 to paragraph .06, the reference to Section 312
is replaced with a reference to Paragraph 11 of Auditing Standard No.
14, Evaluating Audit Results.
    c. Within footnote 7 to paragraph .06, the reference to section
316, Consideration of Fraud in a Financial Statement Audit, paragraphs
.38 through .40, is replaced with a reference to section 316,
Consideration of Fraud in a Financial Statement Audit, paragraphs .79
through .82.
    AU sec. 334, ``Related Parties''
    SAS No. 45, ``Related Parties'' (AU sec. 334 ``Related Parties''),
is amended as follows:
    a. In the second sentence of paragraph .09, the word ``competent''
is replaced with the word ``appropriate.''
    b. In the first sentence of paragraph .11, the word ``competent''
is replaced with the word ``appropriate.''
    c. In footnote 8 to paragraph .11, the reference to section 431,
Adequacy of Disclosure in Financial Statements, is replaced with a
reference to paragraph 31 of Auditing Standard No. 14, Evaluating Audit
Results.
    AU sec. 9334, ``Related Parties: Auditing Interpretations of
Section 334''
    AU sec. 9334, ``Related Parties: Auditing Interpretations of
Section 334,'' is amended as follows: Within footnote 4 to paragraph
.17, the reference to section 312, Audit Risk and Materiality in
Conducting an Audit, is replaced with a reference to Auditing Standard
No. 8, Audit Risk.
    AU sec. 336, ``Using the Work of a Specialist''
    SAS No. 73, ``Using the Work of a Specialist'' (AU sec. 336,
``Using the Work of a Specialist''), is amended as follows:
    a. Footnote 1 to paragraph .01 is replaced with the following:
Because income taxes and information technology are specialized areas
of accounting and auditing, this section does not apply to situations
in which an income tax specialist or information technology specialist
participates in the audit. Auditing Standard No. 10, Supervision of the
Audit Engagement, applies in those situations.
    b. Paragraph .05 is replaced with the following: This section does
not apply to situations in which a specialist employed by the auditor's
firm participates in the audit. Auditing Standard No. 10, Supervision
of the Audit Engagement, applies in those situations.
    c. In the last sentence of paragraph .06, the word ``competent'' is
replaced with the word ``appropriate.''
    d. In the first and last sentences of paragraph .13, the word
``competent'' is replaced with the word ``appropriate.''
    AU sec. 9336, ``Using the Work of a Specialist: Auditing
Interpretations of Section 336''
    AU sec. 9336, ``Using the Work of a Specialist: Auditing
Interpretations of Section 336,'' is amended as follows:
    a. In the second sentence of paragraph .04, the word ``competent''
is replaced with the word ``appropriate.''
    b. In paragraph .05, the word ``competent'' is replaced with the
word ``appropriate.''
    c. In the second sentence of paragraph .11, the word ``competent''
is replaced with the word ``appropriate.''
    d. The penultimate sentence of paragraph .15, is replaced with:
Paragraph 6 of Auditing Standard No. 15, Audit Evidence, states, ``[t]o
be appropriate, audit evidence must be both relevant and reliable in
providing support for the conclusions on which the auditor's opinion is
based.''
    AU sec. 341, ``The Auditor's Consideration of an Entity's Ability
to Continue as a Going Concern''
    SAS No. 59, ``The Auditor's Consideration of an Entity's Ability to
Continue as Going Concern'' (AU sec. 341, ``The Auditor's Consideration
of an Entity's Ability to Continue as a Going Concern''), as amended,
is amended as follows: The reference in paragraph .02 to section 326,
Evidential Matter, is replaced with a reference to Auditing Standard
No. 15, Audit Evidence.
    AU sec. 342, ``Auditing Accounting Estimates''
    SAS No. 57, ``Auditing Accounting Estimates'' (AU sec. 342,
``Auditing Accounting Estimates''), as amended, is amended as follows:
    a. In the first sentence of paragraph .01, the word ``competent''
is replaced with the word ``appropriate.''
    b. In the first sentence of paragraph .07, the word ``competent''
is replaced with the word ``appropriate.''
    c. The text of footnote 3 to paragraph .07 is replaced with: See
paragraph 31 of Auditing Standard No. 14, Evaluating Audit Results.
    d. The reference in paragraph .08 subparagraph b.1. to section 311,
Planning and Supervision, is replaced with a reference to Auditing
Standard No. 12, Identifying and Assessing Risks of Material
Misstatement.
    e. Paragraph .14, is replaced with: Paragraphs 24 through 27 of
Auditing Standard No. 14, Evaluating Audit Results, discuss the
auditor's responsibilities for assessing bias and evaluating accounting
estimates in relationship to the financial statements taken as a whole.
    AU sec. 9342, ``Auditing Accounting Estimates: Auditing
Interpretations of Section 342''

    AU sec. 9342, ``Auditing Accounting Estimates: Auditing
Interpretations of Section 342,'' is amended as follows: In the second
sentence of paragraph .02, the word ``competent'' is replaced with the
word ``appropriate.''
    AU sec. 350, ``Audit Sampling''
    SAS No. 39, ``Audit Sampling'' (AU sec. 350, ``Audit Sampling''),
as amended, is amended as follows:
    a. Within footnote 2 to paragraph .02, the reference to section
312, Audit Risk and Materiality in Conducting an Audit, is replaced
with a reference to Auditing Standard No. 14, Evaluating Audit Results.
    b. The last sentence of paragraph .03 is replaced with: Either
approach to audit sampling can provide sufficient evidential matter
when applied properly. This section applies to both nonstatistical and
statistical sampling.
    c. Paragraph .04 is deleted.
    d. In paragraph .06:
     The first sentence is deleted.
     In the last sentence, the word ``competence'' is replaced
with the word ``appropriateness.''
     The following note is added to the paragraph:
    Note: Auditing Standard No. 15, Audit Evidence, discusses the
appropriateness of audit evidence, and Auditing Standard No. 14,
Evaluating Audit Results, discusses the auditor's responsibilities for
evaluating the sufficiency and appropriateness of audit evidence.
    e. Paragraph .08 is deleted.
    f. In paragraph .09:
     The sentence in paragraph .09 referring to section 313,
which is in parentheses, is deleted.
     The following note is added to the paragraph:
    Note: Auditing Standard No. 8, Audit Risk, describes audit risk and
its components in a financial statement audit--the risk of material
misstatement (consisting of inherent risk and control risk) and
detection risk.
    g. In paragraph .11:
     The phrase ``(see section 311, Planning and Supervision)''
is deleted.
     The sentence ``(See section 313.)'' is deleted.
    h. The second sentence of paragraph .15 is replaced with: See
Auditing Standard No. 9, Audit Planning.
    i. In the first bullet in paragraph .16, the phrase ``(see section
326, Evidential Matter)'' is deleted.
    j. In the second bullet of paragraph .16, the phrase ``Preliminary
judgments about materiality levels'' is replaced with the phrase
``Tolerable misstatement. (See paragraphs .18-18A.)''
    k. Paragraph .18 is replaced with: Evaluation in monetary terms of
the results of a sample for a substantive test of details contributes
directly to the auditor's purpose, since such an evaluation can be
related to his or her judgment of the monetary amount of misstatements
that would be material. When planning a sample for a substantive test
of details, the auditor should consider how much monetary misstatement
in the related account balance or class of transactions may exist, in
combination with other misstatements, without causing the financial
statements to be materially misstated. This maximum monetary
misstatement for the account balance or class of transactions is called
tolerable misstatement.
    l. Paragraph .18A is added: Paragraphs 8-9 of Auditing Standard No.
11, Consideration of Materiality in Planning and Performing an Audit,
describe the auditor's responsibilities for determining tolerable
misstatement at the account or disclosure level. When the population to
be sampled constitutes a portion of an account balance or transaction
class, the auditor should determine tolerable misstatement for the
population to be sampled for purposes of designing the sampling plan.
Tolerable misstatement for the population to be sampled ordinarily
should be less than tolerable misstatement for the account balance or
transaction class to allow for the possibility that misstatement in the
portion of the account or transaction class not subject to audit
sampling, individually or in combination with other misstatements,
would cause the financial statements to be materially misstated.
    m. Paragraph .20 is deleted.
    n. The first sentence of paragraph .21 is replaced with the
following sentence: The sufficiency of tests of details for a
particular account balance or class of transactions is related to the
individual importance of the items examined as well as to the potential
for material misstatement.
    o. Paragraph .23 is replaced with: To determine the number of items
to be selected in a sample for a particular substantive test of
details, the auditor should take into account tolerable misstatement
for the population; the allowable risk of incorrect acceptance (based
on the assessments of inherent risk, control risk, and the detection
risk related to the substantive analytical procedures or other relevant
substantive tests); and the characteristics of the population,
including the expected size and frequency of misstatements.
    p. Paragraph .23A is added: Table 1 of the Appendix describes the
effects of the factors discussed in the preceding paragraph on sample
sizes in a statistical or nonstatistical sampling approach. When
circumstances are similar, the effect on sample size of those factors
should be similar regardless of whether a statistical or nonstatistical
approach is used. Thus, when a nonstatistical sampling approach is
applied properly, the resulting sample size ordinarily will be
comparable to, or larger than, the sample size resulting from an
efficient and effectively designed statistical sample.
    q. The last sentence of paragraph .25 is replaced with: The auditor
also should evaluate whether the reasons for his or her inability to
examine the items have (a) implications in relation to his or her risk
assessments (including the assessment of fraud risk), (b) implications
regarding the integrity of management or employees, and (c) possible
effects on other aspects of the audit.
    r. Footnote 6 to paragraph .26 is replaced with: Paragraphs 10
through 23 of Auditing Standard No. 14, Evaluating Audit Results,
discuss the auditor's consideration of differences between the
accounting records and the underlying facts and circumstances.
    s. Within footnote 7 to paragraph .32, the phrase ``(see section
319.85)'' is deleted. In the first sentence of the footnote, the phrase
``often plans'' is replaced with the phrase ``may plan.'' The last
sentence of the footnote, which is in brackets, is deleted.
    t. The last sentence of paragraph .38 is replaced with: When
circumstances are similar, the effect on sample size of those factors
should be similar regardless of whether a statistical or nonstatistical
approach is used. Thus, when a nonstatistical sampling approach is
applied properly, the resulting sample size ordinarily will be
comparable to, or larger than, the sample size resulting from an
efficient and effectively designed statistical sample.
    u. The fifth sentence of paragraph .39 is replaced with: Paragraphs
44 through 46 of Auditing Standard No. 13, The Auditor's Responses to
the Risks of Material Misstatement, describe the auditor's
responsibilities for performing procedures between the interim date of
testing and period end.
    v. In paragraph .39, the last sentence, which is in brackets, is
deleted.
    w. In paragraph .44:
     The first sentence is replaced with: In some
circumstances, the auditor may design a sample that will be used for
dual purposes: as a test of control and as a substantive test.

     The third sentence is replaced with: For example, an
auditor designing a test of a control over entries in the voucher
register may design a related substantive test at a risk level that is
based on an expectation of reliance on the control.
     The fifth sentence is replaced with: In evaluating such
tests, deviations from the control that was tested and monetary
misstatements should be evaluated separately using the risk levels
applicable for the respective purposes.
     The following Note is added to the paragraph:
    Note: Paragraph 47 of Auditing Standard No. 13, The Auditor's
Responses to the Risks of Material Misstatement, provides additional
discussion of the auditor's responsibilities for performing dual-
purpose tests.
    x. The reference in paragraph .45 to paragraph .04 is changed to a
reference to paragraph .03.
    y. In item 2 of paragraph .48, the last sentence is deleted.
    z. Within footnote 1 to item 4 in paragraph .48, the sentence
``(See section 313.)'' is deleted.
    aa. The sentence in item 6 of paragraph .48 ``(See section 313.)''
is deleted.
    AU sec. 9350, ``Audit Sampling: Auditing Interpretations of Section
350''
    AU sec. 9350, ``Audit Sampling: Auditing Interpretations of Section
350,'' is superseded.
    AU sec. 380, ``Communication With Audit Committees''
    SAS No. 61, ``Communication With Audit Committees'' (AU sec. 380,
``Communication With Audit Committees''), as amended, is amended as
follows:
    In footnote 5 to paragraph .10, the reference to section
316A.38-.40 is replaced with a reference to AU secs. 316.79-.82; the
reference to section 316A is replaced with a reference to section 316.
    AU sec. 411, ``The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles''
    SAS No. 69, ``The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles'' (AU sec. 411, ``The Meaning
of Present Fairly in Conformity with Generally Accepted Accounting
Principles''), as amended, is amended as follows:
    a. In paragraph .04, the reference in (c) to section 431 is
replaced with a reference to paragraph 31 of Auditing Standard No. 14,
Evaluating Audit Results; in (d), the reference to section 431 is
replaced with a reference to paragraph 31 of Auditing Standard No. 14.
    b. The reference in footnote 1 to paragraph .04 to 312.10 is
replaced with a reference to Auditing Standard No. 11, Consideration of
Materiality in Planning and Performing an Audit.
    AU sec. 431, ``Adequacy of Disclosure in Financial Statements''
    SAS No. 32, ``Adequacy of Disclosure in Financial Statements'' (AU
sec. 431, ``Adequacy of Disclosure in Financial Statements''), as
amended, is superseded.
    AU sec. 508, ``Reports on Audited Financial Statements''
    SAS No. 58, ``Reports on Audited Financial Statements'' (AU sec.
508, ``Reports on Audited Financial Statements''), as amended, is
amended as follows:
    a. In paragraph 18C, the phrase ``and in AU sec. 431'' is deleted.
    b. In subparagraph .20.a., the word ``competent'' is replaced with
the word ``appropriate.''
    c. In the second sentence of paragraph .22, the word ``competent''
is replaced with the word ``appropriate.''
    d. In the third sentence of paragraph .24, the word ``competent''
is replaced with the word ``appropriate.''
    e. In footnote 15 to paragraph .38, the first sentence is replaced
with:
    In this context, practicable means that the information is