1. 6 THE AUDIT PROCESS

2. AUDITRESPONSIBILITIES AND OBJECTIVES AUDITRESPONSIBILITIES Audit Objective Primary objective of the audit is to express an opinion on the financial statements Other objectives are secondary

3. FIGURE 6-1 Steps to Develop Audit Objectives Understand objectives and responsibilities for the audit Divide financial statements into cycles or balances Know management assertions about accounts Know general audit objectives for classes of transactions and accounts Know specific audit objectives for classes of transactions and accounts 1 2 3 4 5

4. Management vs. Auditor Responsibilities Responsibilities Management Financial statement Internal controls Management Financial statement Internal controls Auditor Issue opinion on fairness of F/S’s Auditor Issue opinion on fairness of F/S’s 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. SOX requires the CEO and the CFO of public companies to certify the quarterly and annual financial statements submitted to the SEC.

5. . Examination-Objective-Opinion-Fairness- FS Presentation. Other objectives are secondary!. Provides reasonable assurance financial statement are free from material misstatement. Audit performed with professional skepticism

6. CATEGORY 1 Management’s Characteristics and Influence over the Control Environment These pertain to management’s abilities, pressures, style, and attitude relating to internal control and the financial reporting process. CATEGORY 2 Industry Conditions These involve the economic and regulatory environment in which the entity operates. CATEGORY 3 Operating Characteristics and Financial Stability These pertain to the nature and complexity of the entity and its transactions, financial condition, and profitability Examples of Risk Factors A motivation for management to engage in fraudulent financial reporting, such as an excessive interest by management to maintain or increase the entity’s stock price or earnings trend through the use of unusually aggressive accounting practices. A failure by management to display and communicate an appropriate attitude regarding internal control and the financial reporting process, such as domination of management by a single person or small group without compensating controls. High turnover of senior management, counsel, or board members. Examples of Risk Factors New accounting, statutory, or regulatory requirements that could impair the financial stability or profitability of the entity. Declining industry with increasing business failures and significant declines in customer demand. Rapid changes in the industry, such as high vulnerability to rapidly changing technology or rapid product obsolescence. Examples of Risk Factors Significant pressure to obtain additional capital necessary to stay competitive considering the financial position of the entity. Significant, unusual, or highly complex transactions, especially those close to yearend, that pose difficult “substance over form” questions. Overly complex organizational structure involving numerous or unusual legal entities, managerial lines of authority, or contractual arrangements without apparent business purpose. The Three SAS 82 (SAS 99) Categories of Risk Factors for Fraudulent Financial Reporting & Three Examples of Each

7. The Two SAS 82 (SAS 99) Categories of Risk Factors for Misappropriation of Assets and Two Examples of Each of Assets and Two Examples of Each The Two SAS 82 (SAS 99) Categories of Risk Factors for Misappropriation of Assets and Two Examples of Each of Assets and Two Examples of Each CATEGORY 1 Susceptibility of Assets to Misappropriation These pertain to the nature of an entity’s assets and the degree to which they are subject to theft. CATEGORY 2 Controls These involve the lack of controls designed to prevent or detect misappropriations of assets. Examples of Risk Factors Large amounts of cash on hand or processed Easily convertible assets, such as bearer bonds, diamonds, or computer chips Fixed asset characteristics, such as small size, marketability, or lack of ownership identification Examples of Risk Factors Lack of appropriate management oversight such as inadequate supervision or monitoring of remote locations Inadequate record keeping with respect to assets susceptible to misappropriation Lack of timely and appropriate documentation for transactions, such as credits for merchandise returns

8. Responsibilities for Discovering Illegal Acts Direct-Effect Illegal Acts (same as errors & irregs) Indirect-Effect Illegal Acts (No assurance) Evidence Accumulation When There is No Reason to Believe Indirect-Effect Illegal Acts exist (no resp.) Evidence Accumulation and Other Actions When There is Reason to Believe Direct - or Indirect-Effect Illegal Acts May Exist (inquire, consult, consider more evidence) Actions when the Auditor Knows of an Illegal Act (consider f/s Effect, BOD’s/Audit Cte., collect sufficient evidence)

9. Divide and Conquer Audits are performed by dividing the financial statements into smaller segments or components. This is done using a cycle approach or a balance approach.

10. Sales Journal Cash Receipts Cash Receipts Journal Acquisition of Goods & Services Acquisition Journal Cash Disbursements Cash Disbursements Journal Payroll Services & Disbursements Payroll Journal Allocation and Adjustments General Journal General Ledger and Subsidiary Records General Ledger Trial Balance Financial Statements TRANSACTIONSJOURNALS LEDGERS, TRIAL BALANCES, AND FINANCIAL STATEMENTS The Cycle Approach to segmenting an audit

11. Relationships among Transaction Cycles General Cash General Cash Capital Acquisition and Repayment Cycle Capital Acquisition and Repayment Cycle Sales and Collection Cycle Sales and Collection Cycle Inventory and Warehousing Cycle Inventory and Warehousing Cycle Acquisition and Payment Cycle Acquisition and Payment Cycle Payroll and Personnel Cycle

12. SETTING AUDIT OBJECTIVES Balance and Transactions Affecting Those Balances for Accounts Receivable Accounts Receivable Beginning balance$ 96 $660 Sales Ending balance$105 $590 $ 26 $ 35 Cash receipts Sales returns and allowances Charge-off of uncollectible accounts

13. Management Assertions for Each Category of Assertions Assertions About Classes of Transactions and Events Assertions About Account Balances Assertions About Presentation and Disclosure OccurrenceExistenceOccurrence and rights and obligations Completeness AccuracyValuation and allocation Accuracy and valuation ClassificationClassification and understandability Cutoff Rights and obligations