2. 6 - 1 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Audit Responsibilities and Objectives Chapter 6

3. 6 - 2 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 1 Explain the objective of conducting an audit of financial statements and an audit of internal controls.

4. 6 - 3 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

5. 6 - 4 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

6. 6 - 5 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

7. 6 - 6 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

8. 6 - 7 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Management’s Responsibilities 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.

9. 6 - 8 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Management’s Responsibilities Management’s Responsibilities The Sarbanes-Oxley Act provides for criminal penalties for anyone who knowingly falsely certifies the statements.

10. 6 - 9 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 3 Explain the auditor’s responsibility for discovering material misstatements.

11. 6 - 10 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Auditor’s Responsibilities –Material versus immaterial misstatements –Reasonable assurance –Errors versus fraud –Professional skepticism –Fraud resulting from fraudulent financial reporting versus misappropriation of assets

12. 6 - 11 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

13. 6 - 12 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Auditor’s Responsibilities for Discovering Illegal Acts Evidence accumulation and other actions when there is reason to believe direct- or when there is reason to believe direct- or indirect-effect illegal acts may exist Actions when the auditor knows of an illegal act

14. 6 - 13 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 4 Classify transactions and account balances into financial statement cycles and identify benefits of a cycle approach to segmenting the audit.

15. 6 - 14 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Financial Statements Cycles Audits are performed by dividing the financial statements into smaller segments or components.

16. 6 - 15 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Transaction Flow Example Ledgers, Trial Balance, and Financial Statements General ledger and subsidiary records General ledger trial balance Financialstatements Acquisition of goods and services Sales CashreceiptsTransactions Cash receipts journal Salesjournal AcquisitionsjournalJournals

17. 6 - 16 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Transaction Flow Example Allocationandadjustments Cashdisbursements Payroll services and disbursementsLedgers, Trial Balance, and Financial Statements General ledger and subsidiary records General ledger trial balance Financialstatements Transactions Payrolljournal Cashdisbursementsjournal GeneraljournalJournals

18. 6 - 17 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Relationships Among Transaction Cycles Generalcash Capital acquisition and repayment cycle Sales and collectioncycleAcquisition and payment cycle Payroll and personnelcycle Inventory and warehousingcycle

19. 6 - 18 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 5 Describe why the auditor obtains a combination of assurance by auditing class of transactions and ending balances in accounts.

20. 6 - 19 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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 uncollectibleaccounts Ending balance $ 20,197 $ 3,323 Accounts Receivable (in thousands)

21. 6 - 20 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 6 Distinguish among the five categories of management assertions about financial information.

22. 6 - 21 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Management Assertions 1. Existence or occurrence 2. Completeness 3. Valuation or allocation 4. Rights and obligations 5. Presentation and disclosure

23. 6 - 22 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 7 Link the six general transaction- related audit objectives to the five management assertions.

24. 6 - 23 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Transaction-Related Audit Objectives and Management Assertions Management Assertions General Transaction- Related Audit Objectives Existence or occurrence Completeness Valuation or allocation Existence Completeness AccuracyClassificationTiming Posting and summarization Rights and obligations Presentation and disclosure N/A N/A

25. 6 - 24 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

26. 6 - 25 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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. Transaction-Related Audit Objectives and Management Assertions

27. 6 - 26 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 8 Link the nine general balance- related audit objectives to the five management assertions.

28. 6 - 27 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Assertions and Balance-Related Audit Objectives Management Assertions General Balance Related Audit Objectives Existence or occurrence Completeness Valuation or allocation Existence Completeness AccuracyClassification Cut-off, Detail tie-in Realizable value Rights and obligations Presentation and disclosure Rights and obligations Presentation and disclosure

29. 6 - 28 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Existence Amounts included exist. Completeness Existing amounts are included. Accuracy Amounts included are stated at the correct amounts. General Balance-Related Audit Objectives

30. 6 - 29 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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

31. 6 - 30 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Realizablevalue Assets are included at estimated realizable value. Rights and obligations Assets must be owned. Presentationanddisclosure Account balances and disclosures are presented in financial statements. General Balance-Related Audit Objectives

32. 6 - 31 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Learning Objective 9 Explain the relationship between audit objectives and the accumulation of audit evidence.

33. 6 - 32 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 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.

34. 6 - 33 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder Four Phases of a Financial Statement Audit Phase I Plan and design an audit approach. Phase II Perform tests of controls and substantive tests of transactions. Phase III Perform analytical procedures and tests of details of balances. Phase IV Complete the audit and issue an audit report.

35. 6 - 34 ©2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder End of Chapter 6