Audit Responsibilities and Objectives Chapter 6

Learning Objective 1 Explain the objective of conducting an audit of financial statements and an audit of internal controls.

Objective of Conducting an Audit of Financial Statements The objective of the ordinary audit of financial statements is the expression of an opinion of the fairness with which they present fairly, in all respects, financial position, result of operations, and its cash flows in conformity with GAAP.

Steps to Develop Audit Objectives Understand objectives and responsibilities for the audit. 1 2 Divide financial statements into cycles. 3 Know management assertions about accounts.

Steps to Develop Audit Objectives Know general audit objectives for classes of transactions and accounts. 4 5 Know specific audit objectives for classes of transactions and accounts.

Learning Objective 2 Distinguish management’s responsibility for the financial statements and internal control from the auditor’s responsibility for verifying the financial statements and effectiveness of internal control.

Management’s Responsibilities Management is responsible for the financial statements and for internal control. The Sarbanes–Oxley Act increases management’s responsibility for the financial statements. It requires the CEO and the CFO of public companies to certify the quarterly and annual financial statements submitted to the SEC.

Management’s Responsibilities The Sarbanes-Oxley Act provides for criminal penalties for anyone who knowingly falsely certifies the statements.

Learning Objective 3 Explain the auditor’s responsibility for discovering material misstatements.

Auditor’s Responsibilities – Material versus immaterial misstatements – Reasonable assurance – Errors versus fraud – Professional skepticism – Fraud resulting from fraudulent financial reporting versus misappropriation of assets

Auditor’s Responsibilities for Discovering Illegal Acts Direct-effect illegal acts Indirect-effect illegal acts Evidence accumulation when there is no reason to believe indirect-effect illegal act exists

Auditor’s Responsibilities for Discovering Illegal Acts Evidence accumulation and other actions when there is reason to believe direct- or indirect-effect illegal acts may exist Actions when the auditor knows of an illegal act

Learning Objective 4 Classify transactions and account balances into financial statement cycles and identify benefits of a cycle approach to segmenting the audit.

Financial Statements Cycles Audits are performed by dividing the financial statements into smaller segments or components.

Transaction Flow Example Ledgers, Trial Balance, and Financial Statements General ledger and subsidiary records Acquisition of goods and services Sales Cash receipts Transactions Cash receipts journal Sales Acquisitions Journals General ledger trial balance Financial statements

Transaction Flow Example Ledgers, Trial Balance, and Financial Statements General ledger and subsidiary records trial balance Financial statements Transactions Payroll journal Cash disbursements General Journals Cash disbursements Payroll services and disbursements Allocation and adjustments

Relationships Among Transaction Cycles General cash Capital acquisition and repayment cycle Sales and collection cycle Acquisition and payment Payroll and personnel Inventory and warehousing

Learning Objective 5 Describe why the auditor obtains a combination of assurance by auditing class of transactions and ending balances in accounts.

Balance and Transactions Affecting Balances Example Beginning balance Sales $ 17,521 $144,328 $137,087 Cash receipts $ 1,242 Sales returns and allowances Charge-off of uncollectible accounts Ending balance $ 20,197 $ 3,323 Accounts Receivable (in thousands)

Learning Objective 6 Distinguish among the five categories of management assertions about financial information.

Management Assertions 1. Existence or occurrence 2. Completeness 3. Valuation or allocation 4. Rights and obligations 5. Presentation and disclosure

Learning Objective 7 Link the six general transaction- related audit objectives to the five management assertions.

Transaction-Related Audit Objectives and Management Assertions General Transaction- Related Audit Objectives Existence or occurrence Completeness Valuation or allocation Existence Accuracy Classification Timing Posting and summarization Rights and obligations Presentation and disclosure N/A

Transaction-Related Audit Objectives and Management Assertions Existence Recorded transactions exist. Completeness Existing transactions are recorded. Accuracy Recorded transactions are stated at the correct amounts.

Transaction-Related Audit Objectives and Management Assertions Classification Transactions are properly classified. Timing Transactions are recorded on the correct dates. Posting and summarization Transactions are included in the master files and are correctly summarized.

Learning Objective 8 Link the nine general balance- related audit objectives to the five management assertions.

Assertions and Balance-Related Audit Objectives Management Assertions General Balance Related Audit Objectives Existence or occurrence Completeness Valuation or allocation Existence Accuracy Classification Cut-off, Detail tie-in Realizable value Rights and obligations Presentation and disclosure

General Balance-Related Audit Objectives Existence Amounts included exist. Completeness Existing amounts are included. Accuracy Amounts included are stated at the correct amounts.

General Balance-Related Audit Objectives Classification Amounts are properly classified. Cutoff Transactions are recorded in the proper period. Detail tie-in Account balances agree with master file amounts, and with the general ledger.

General Balance-Related Audit Objectives Realizable value Assets are included at estimated realizable value. Rights and obligations Assets must be owned. Presentation and disclosure Account balances and disclosures are presented in financial statements.

Learning Objective 9 Explain the relationship between audit objectives and the accumulation of audit evidence.

How Audit Objectives Are Met The auditor must obtain sufficient competent audit evidence to support all management assertions in the financial statements. An audit process is a methodology for organizing an audit.

Four Phases of a Financial Statement Audit Phase I Plan and design an audit approach. Phase III Perform analytical procedures and tests of details of balances. Phase II Perform tests of controls and substantive tests of transactions. Phase IV Complete the audit and issue an audit report.

End of Chapter 6