Audit Responsibilities and Objectives Chapter 6

Key Topics in Chapter 6 Understand the responsibility of : Management, for the financial statements and internal controls The independent auditor: SAS 1 – auditor’s responsibility in performing the audit For discovering illegal acts Understand the four phases of a financial statement audit

Key Topics in Chapter 6 Be familiar with the different transaction cycles Know the management assertions Know the general transaction-related and general balance-related audit objectives

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.

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.

Auditor’s Responsibilities Material versus immaterial misstatements Combined uncorrected errors likely to affect A user’s decision are usually considered material Errors vs. fraud Both are a potential source of material misstatement, however, fraud has further implications. Reasonable assurance Not a guarantee Professional skepticism The attitude we adopt in all aspects of the engagement

Auditor’s Responsibilities for Discovering Illegal Acts Direct-effect vs. Indirect-effect illegal acts * Auditors have the same responsibility for detecting direct-effect illegal acts, as they do fraud. * Auditors provide no assurance indirect-effect illegal acts will be detected Evidence accumulation when there is no reason to believe indirect-effect illegal act exists * Inquiries of management and the B.O.D., reading the B.O.D. minutes.

Auditor’s Responsibilities for Discovering Illegal Acts Actions when the auditor knows of an illegal act * Consider effects on the financial statements and disclosures. More evidence may be required. * Who you gonna tell? Within the client’s company Outside the client’s company

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

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

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

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.

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.

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)

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.

Announcements First midterm next Wednesday, Feb. 1. A topic guide that will summarize the main items that could be represented on the midterm will be available on the website within the next 2 days. Next class: guest professors from PwC will present material from Chapter 6.