1. Audit Responsibilities and Objectives

2. 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.

3. Steps to Develop Audit Objectives

4. 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.

5. 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.

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

7. auditor’s responsibility
The auditor is responsible of planning and performing the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.
The auditor is able to obtain reasonable BUT not absolute assurance that material misstatements are detected.
The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements (caused by errors or fraud) that are not material to the financial statements are detected.

8. Material versus immaterial misstatements
Misstatements are considered material if the combined uncorrected errors and fraud in the financial statements would likely have changed or influenced the decision of reasonable person.
It would be extremely costly (and impossible) for auditors to have responsibility for finding all immaterial errors and fraud.
Auditors are responsible for obtaining reasonable assurance.

9. Reasonable assurance
Assurance is a measure of the level of certainty that the auditor has obtained at the completion of the audit.
Reasonable assurance is a high, but not absolute, level of assurance that the financial statements are free of material misstatements.
The auditor is responsible for reasonable assurance for the following reasons :
Testing samples.
Estimations.
Fraud is extremely difficult to detect.

10. Errors versus fraud Errors: are unintentional misstatements.
Fraud: are intentional misstatements.
1. Misappropriation of Assets (Employee Fraud).
Harms stockholders and creditors because assets are no longer available.
2. Fraudulent Financial Reporting.(management Fraud).
Harms users by providing them incorrect financial statement information for their decision making.

11. Professional skepticism
The audit must be planned and performed with an attitude of professional skepticism.
Auditor should not assume that management is dishonest, BUT the possibility of dishonesty must be considered.

12. Auditor’s Responsibilities for Discovering Illegal Acts
Illegal acts : violation of laws or government regulations other than fraud.
Violation of tax laws.
Violation of environmental protection laws.

13. Direct-effect illegal acts
Have a direct financial effect on specific account balances in the financial statements.
EX: violation of tax laws affects income tax expenses and income tax payable.

14. Indirect-effect illegal acts
Affect financial statements only indirectly.
EX: violation of environmental protection laws, financial statements are only affected if there is a fine or sanctions.

15. Actions when the auditor knows of an illegal act
Consider the effect on the financial statements, including the adequacy of disclosures.
Effect on the relationship with management (if management knew of the illegal act).
Communicate with audit committee to make sure they know of the illegal act.
If client refuses of fails to take appropriate action, the auditor may withdrew from the engagement.
If client is publicly held the auditor must report to the SEC.

16. Financial Statements Cycles
Audits are performed by dividing the financial statements into smaller segments or components.
Keeping closely related types (or classes) of transactions and account balances in the same segment.
After the audit of each segment is completed, including interrelationships with other segments, the results are combined. A conclusion can be reached about the financial statements taken as a whole.

17. Setting audit objectives
Transaction related audit objectives.
Balance related audit objectives.
Presentation and Disclosure audit objectives.

18. Managements Assertions
Are implied or expressed representations by management about classes of transactions and the related accounts and disclosures in the financial statements.
Assertions are classified into three categories :
Assertions about classes of transactions and events for the period under audit.
Assertions about account balances at period end.
Assertions about presentation and disclosure.

19. Assertions about classes of transactions and events
Occurrence: transactions included in the financial statements Actually occurred during the accounting period.Ex: recorded sales.
Is concerned with the possibility of including transactions that should not been included
Relates to account overstatement.
Completeness: all transactions that should be included in the financial statements are in fact included. Ex: all sales are recorded.
Opposite from occurrence.
Is concerned with the possibility of omitting transactions.
Relates to account understatement.

20. Accuracy: whether transactions have been recorded at correct amounts.
Classification: whether transactions are recorded in the appropriate accounts.
Cutoff: whether transactions are recorded in the proper accounting period.

21. Assertions about account balances
Existence: whether assets, liabilities, and equity included in the balance sheet actually existed on the balance sheet date.
Is concerned with the possibility of including amounts that should not been included.
Relates to account overstatement.
Completeness: whether all accounts and amounts that should be presented in the financial statements are in fact included.
Is concerned with the possibility of omitting items.
Relates to account understatement.

22. Valuation and Allocation: whether assets, liabilities and owners interests have been included in the financial statements at appropriate amounts, including any valuation adjustments to reflect assets amounts at net realizable value.
Rights and obligations: whether assets are the rights of the entity and whether liabilities are the obligations of the entity.

23. Assertions about presentation and disclosure
Occurrence and rights and obligations: whether disclosed events have occurred and are the rights and obligations of the entity.
Completeness: whether all required disclosures have been included in the financial statements. EX: all material related party transactions have been disclosed.
Accuracy and valuation: whether financial information is disclosed fairly and at appropriate amounts.
Classification and Understandability: whether amounts are appropriately classified in the financial statements and in the footnotes. EX: classification of inventory.

24. Management Assertions for Each Category of Assertions
Assertions About Classes
of Transactions and Events
Assertions About
Account Balances
Assertions About
Presentation and Disclosure
Occurrence
Existence
Occurrence and rights
and obligations
Completeness
Completeness
Completeness
Accuracy
Valuation and
allocation
Accuracy and
valuation
Classification
Classification and
understandability
Cutoff
Rights and
obligations

25. General Transactions-related Audit Objectives
Occurrence: Recorded transactions exist.
Deals with potential overstatement.
Completeness: Existing transactions are recorded.
Deals with potential Understatement.
Accuracy: A-Recorded transactions are stated at the correct amounts.
B-posting and summarization : Transactions are included in the master files and are correctly summarized.
Classification: Transactions are properly classified.
Timing: Transactions are recorded on the correct dates.

26. Transaction Related Audit Objectives
Management Assertions
About Classes of
Transactions and Events
General Transaction-
related Audit
Objectives
Specific Sales Transaction-
related Audit Objectives
Occurrence
Occurrence
Recorded sales are for
shipments made to
nonfictitious customers
Completeness
Completeness
Existing sales
transactions are recorded
Accuracy
Accuracy
Recorded sales are for
the amount of goods
shipped and are correctly
billed and recorded

27. Transaction Related Audit Objectives
Management Assertions
About Classes of
Transactions and Events
General Transaction-
related Audit
Objectives
Specific Sales Transaction-
related Audit Objectives
Accuracy
Posting and
summarization
Sales transactions are
properly included in the
master file and are
correctly summarized
Classification
Classification
Sales transactions are
properly classified
Cutoff
Timing
Sales transactions are
recorded on the correct
dates.

28. Balance-related Audit Objectives
Existence: amounts included Exist. Inclusion of an A/R from a customer in the trial balance when there is no receivable violates this objective.
Counterpart to the management assertion of existence.
Deals with overstatement.
Completeness: Existing amounts are included. Failure to include an A/R from a customer in the trial balance.
Counterpart to the management assertion of completeness.
Deals with understatement.

29. Accuracy:
A) Amounts included are stated at the correct amounts: the amounts should be included at the correct amount.
B) Classification: Amounts are properly classified. EX: classifying assets .
C) Cutoff: Transactions are recorded in the proper period.
D) Detail tie-in: Account balances agree with master file amounts, and with the general ledger.

30. Realizable value: Assets are included at estimated realizable value
Realizable value: Assets are included at estimated realizable value.(reduce historical cost or fair market value is required).
Rights and obligations: Assets must be owned and liabilities must belong to the entity.

31. Balance Related Audit Objectives
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance-
related Audit
Objectives
Specific Balance-related Audit
Objectives Applied to Inventory
Existence
Existence
All recorded inventory exists
at the balance sheet date
Completeness
Completeness
All existing inventory has
been counted and included
in the inventory summary

32. Balance Related Audit Objectives
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance-
related Audit
Objectives
Specific Balance-related Audit
Objectives Applied to Inventory
Valuation and
allocation
Accuracy
Inventory quantities on the
client’s perpetual records
agree with items physically
on hand
Prices used to value
inventories are materially
correct
Extensions of price times
quantity are correct and
details are correctly added

33. Balance Related Audit Objectives
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance-
related Audit
Objectives
Specific Balance-related Audit
Objectives Applied to Inventory
Valuation and
allocation
Classification
Cutoff
Inventory items are properly
classified as to raw
materials, work in process,
and finished goods
Purchase cutoff at year end
is proper
Sales cutoff at year end is
proper

34. Balance Related Audit Objectives
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance-
related Audit
Objectives
Specific Balance-related Audit
Objectives Applied to Inventory
Valuation and
allocation
Detail tie-in
Realizable
value
Total of inventory items
agrees with general ledger
Inventories have been written
down where net realizable
value is impaired
Rights and obligations
Rights and
obligations
The company has title to all
inventory items listed
Inventories are not pledged
as collateral

35. Presentation and Disclosure Audit objectives
(Applied to Notes Payable)
Management
Assertions About
Presentation and
Disclosure
General
Presentation-
and Disclosure-
related Audit
Objectives
Specific Presentation and
Disclosure-related Audit Objectives
Applied to Notes Payable
Occurrence
and rights and
obligations
Occurrence
and rights and
obligations
Notes payable as described in the
footnotes exist and are
obligations of the company
Completeness
Completeness
All required disclosures related
to notes payable are included in
the financial statement footnotes

36. Presentation and Disclosure Audit objectives
(Applied to Notes Payable)
Management
Assertions About
Presentation and
Disclosure
General
Presentation-
and Disclosure-
related Audit
Objectives
Specific Presentation and
Disclosure-related Audit Objectives
Applied to Notes Payable
Valuation and
allocation
Valuation and
allocation
Footnote disclosures related to
notes payable are accurate.
Classification
and
understandability
Classification
and
understandability
Notes payable are appropriately
classified as to short-term and
long-term obligations and
related financial statement
disclosures are understandable

37. How Audit Objectives Are Met
The auditor must obtain sufficient appropriate audit evidence to support all management assertions in the financial statements.
The auditor must decide the appropriate audit objectives and evidence to accumulate to meet those objectives on every audit.
To do this auditors follow an audit process.
Audit process: methodology for organizing an audit to ensure that the evidence gathered is both sufficient and appropriate and that all required audit objectives are both specified and met.

38. 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

39. Phase I Plan and design an audit approach
There are two considerations affecting the approach the auditor selects to accumulate evidence:
Sufficient appropriate evidence must be accumulated.
The cost of accumulating the evidence should be minimized.
Planning and designing au audit approach can be broken down into several parts :
Obtain an understanding of the entity and its Environment.
Understand internal control and assess control risk.
Assess Risk of material misstatement.

40. Phase II Perform tests of controls and substantive tests of transactions
By performing TESTS of CONTROLS the auditor can justify reducing planned assessed control risk when controls are believed to be effective.
SUBSTANTIVE Test of Transactions : evaluate the clients recording of transactions.

41. Phase III Perform analytical procedures and tests of details of balances
Analytical procedures : use comparisons and relationships. EX : examine the sales journal and compare results to prior periods.
Tests of Details : specific procedures intended to test for monetary misstatements in the balances in the financial statements. EX: direct written communication with client’s customers to decide on the accuracy of A/R.

42. Phase IV Complete the audit and issue an audit report
Reach and overall conclusion as to whether the financial statements are free of material misstatements.