Chapter 5 – Audit

CAS 200 tells us that the purpose of an audit is to express an opinion on financial statements and
determine if they are presented fairly. If they aren’t presented fairly they have a duty to notify users

Managements role is to adopt sound financial reporting framework in production of financial

statements lies with management. The auditors knowledge is limited to that aquired during the audit.

Responsibilities of those charged with governance

Corp governance is the set of relationships between management and its board, shareholders, and
other stakeholders. Also provides structure through which the companies objectives are set. These are
typically done by the board of governenrs. They are charged with oversight and financial statement
audit. Public companies are required to have audit committees.

Auditors responsibility

 Reasonable assurance that financial statements are free from material misstatement
 Report on the financial statements in accordance with CAS

Material vs Immaterial misstatements

Misstatements are material if uncorrected they would have changed or influenced the decision of the
person using the financial statements.

Reasonable Assurance

Assurance is a measure of the level of certainty the auditor has obtained upon completion of the audit.
Reasonable level of assurance. An audit conducted in accordance with auditing standards may fail to
detect misstatement.

Reasons for reasonable but not absolute

1. Most audit evidence involves a test of a sample population, sampling inevitably includes some
risk
2. Accountant calculations contain complex estimates that inherently involve uncertainty regarding
future transactions
3. Fradulently prepared financial statement are often difficult for the auditor to detect, especially
when there is collusion among management

Errors vs Fraud

Intent is what matters here. Intent to deceive is fraud, misstatement with no intent is just an error.

Further distinguishing between misappropriation of assets which is called employee fraud and
fraudulent financial reporting which is management fraud.

Professional Skepticism

In order to detect material errors and frauds professional skepticism is needed. A questioning mind and
critical assessment of audit evidence.
Auditors Responsibilities

Misapropriation of assets is typically easier to detect than fraud. Management has the ability to override
controls. Financial statement fraud impacts the financial statements.

Auditor has to audit with regulations in mind.

Financial Statement Cycles

Audits are done by dividing financial statements into segments. The cycle approach is dividing closely
related types of transactions in the same segment. Sales, cash receipts, etc. To journals, to general
ledger, to financial statements.

Relationships

Cycle allows the auditor to focus on the flow of transactions and identify points where there is a risk of
misstatement.

Setting Audit Objectives

Overall objective is to determine if financial statements are free from material misstatements.

Assertions – Transactions

Occurrence – Management is looking to ensure that all recorded transcations are included in the
financial statements. They are answering if the recorded transactions really occurred.

Management assertions is what management is claiming about financial statements and transactions.
We are seeking to test their assertions.

Three assertions

 Assertions about transactions and events

o Income statement related
 Assertions about account balances on the b/s
 Assertions about presentation and disclosure

Assertions about transactions and events

Here we focus on the income statement

Occurrence – recorded transactions exists. Did the sale actually occur, were the expenses actually
incurred. Test it. All sales are for nonfictitious customers. Are these sales real, are these expenses real.

Verify that the transaction occurred.

Sales are genuine and not overstated. Here you select a sample of entries in the sales account and trace
it to appropriate sales invoices

Completeness – The transactions are recorded, did we record all sales and expenses. Everything you see
is what is there. We are not hiding anything. Existing sales transactions are recorded.
Select a series of invoices and ensure that they have been recorded. For completeness the procedure
starts at the underlying documents. For occurrence you look at the account and then search for
supporting material. Procedure starts with underlying documents.

Accuracy – Recorded at the correct amount, deals with dollar amounts. Recorded sales are for the
amount they were shipped for. $$$

Classification – did we use proper debit and credit accounts

Cut off – transactions are recorded on the right date

I have to collect appropriate evidence for these assertions.

Have to check for everything to ensure that we can fairly state that sales are correctly prese realnted.

Balance Sheet

Assets liabilities equity

Existence – Assets and liabilities exist. Are they real. I want to see. Physically present. Are they real.
Physically somewhere. No overstatement. No ficticious amounts included. Relevent tests include
physical verification.

Look at the inventory and see if it is actuall there

Completeness – Existing amounts are included. Did we account for all assets? Did we miss a liability? All
the inventory owned is recorded. There isn’t unrecorded inventory elsewhere. Have a list of all
inventory and check.

Valuation – Amounts are stated at correct amounts. Are we reporting at the correct number

Classification – Amounts included in the clients listing are properly classified. Current vs non current
assets

Cut off – accounts recorded at the right perid

Rights and obligations = Assets are owned or controlled by the entity? Liabilities are obligations of the
entity. Sold or owned by someone else

For every account we need to address all these. Just because the assets exist doesn’t mean it’s complete
etc. We have to test for each of these assertions.

Examples

a. Assertion about account balance – classification

b. Assertion about transaction and events – cut off
c. Assertion about account balance – valuation
d. Assertion about transaction and events – classification, proper debit and credits
e. Ignore
f. Assertion about account balances – completeness
 g. Ignore
h. Assertion about classes of transactions and events – accuracy
i. Assertion about account balances – existence
j. Ignore
k. Assertion about classes of transactions and events – occurrence

We want to assure that every account is appropriate. Management is asserting to us that these are the
books. They don’t have a second book.

Assertion is a statement one believes is true