Audit Responsibilities and Objectives

Chapter 6

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 1
Explain the objective of conducting an audit of financial statements and an audit of internal controls.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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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.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Steps to Develop Audit Objectives

1. Understand objectives and responsibilities for the audit. 2. Divide financial statements into cycles. 3. Know management assertions about accounts.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Steps to Develop Audit Objectives

4. Know general audit objectives for classes of transactions and accounts. 5. Know specific audit objectives for classes of transactions and accounts.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 2
Distinguish managements responsibility for the financial statements and internal control from the auditors responsibility for verifying the financial statements and effectiveness of internal control.
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Managements Responsibilities
Management is responsible for the financial statements and for internal control. The Sarbanes-Oxley Act increases managements 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.
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Managements Responsibilities
The Sarbanes-Oxley Act provides for criminal penalties for anyone who knowingly falsely certifies the statements.

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Learning Objective 3
Explain the auditors responsibility for discovering material misstatements.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Auditors Responsibilities
Material versus immaterial misstatements Reasonable assurance Errors versus fraud

Professional skepticism
Fraud resulting from fraudulent financial reporting versus misappropriation of assets
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Auditors 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

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Auditors Responsibilities for Discovering Illegal Acts

Evidence accumulation and other actions when there is reason to believe direct- or indirect-effect illegal acts may exist Actions when the auditor knows of an illegal act

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 4
Classify transactions and account balances into financial statement cycles and identify benefits of a cycle approach to segmenting the audit.

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Financial Statements Cycles

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

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Transaction Flow Example

Transactions Sales Journals Sales journal Ledgers, Trial Balance, and Financial Statements General ledger and subsidiary records General ledger trial balance Financial statements
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Cash receipts

Cash receipts journal

Acquisition of goods and services

Acquisitions journal

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Transaction Flow Example

Transactions Cash disbursements Journals Cash disbursements journal Ledgers, Trial Balance, and Financial Statements General ledger and subsidiary records General ledger trial balance Financial statements
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Payroll services and disbursements Allocation and adjustments

Payroll journal

General journal

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Relationships Among Transaction Cycles

General cash Capital acquisition and repayment cycle Sales and collection cycle Inventory and warehousing cycle
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Acquisition and payment cycle

Payroll and personnel cycle

Learning Objective 5
Describe why the auditor obtains a combination of assurance by auditing classes of transactions and ending balances in accounts, including presentation and disclosure.
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Balance and Transactions Affecting Balances Example

Accounts Receivable (in thousands) Beginning balance $ 17,521

Sales

$144,328

$137,087 Cash receipts

Sales returns 1,242 and allowances Charge-off of 3,323 uncollectible accounts

$ Ending balance $ 20,197

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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Learning Objective 6
Distinguish among the three categories of management assertions about financial information.

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Management Assertions
1. Assertions about classes of transactions and events for the period under audit 2. Assertions about account balances a period end

3. Assertions about presentation and disclosure

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Management Assertions for Each Category of Assertions

Assertions About Classes of Transactions and Events Assertions About Assertions About Account Balances Presentation and Disclosure

Occurrence Completeness Accuracy Classification Cutoff

Existence Completeness Valuation and allocation

Occurrence and rights and obligations Completeness Accuracy and valuation Classification and understandability

Rights and obligations

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Learning Objective 7
Link the six general transactionrelated audit objectives to management assertions for classes of transaction.

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General Transactions-related Audit Objectives

Occurrence Recorded transactions exist Existing transactions are recorded Recorded transactions are stated at the correct amounts
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Completeness

Accuracy

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

General Transactions-related Audit Objectives

Posting and summarization Transactions are included in the master files and are correctly summarized. Transactions are properly classified. Transactions are recorded on the correct dates.
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Classification

Timing

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Management Assertions and Transaction-related Audit Objectives

Hillsburg Hardware Company: As Applied to Sales Transactions
Management Assertions About Classes of Transactions and Events General Transactionrelated Audit Objectives Specific Sales Transactionrelated Audit Objectives

Occurrence

Occurrence

Recorded sales are for shipments made to nonfictitious customers Existing sales transactions are recorded Recorded sales are for the amount of goods shipped and are correctly billed and recorded
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Completeness Accuracy

Completeness Accuracy

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Management Assertions and Transaction-related Audit Objectives

Hillsburg Hardware Company: As Applied to Sales Transactions
Management Assertions About Classes of Transactions and Events General Transactionrelated Audit Objectives Specific Sales Transactionrelated Audit Objectives

Accuracy

Posting and summarization

Sales transactions are properly included in the master file and are correctly summarized Sales transactions are properly classified

Classification

Classification

Cutoff

Timing

Sales transactions are recorded on the correct dates.

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2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Learning Objective 8
Link the eight general balancerelated audit objectives to management assertions for account balances.

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General Balance-related Audit Objectives

Existence Amounts included exist

Completeness

Existing amounts are included

Amounts included are stated at the correct amounts
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Accuracy

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

General Balance-related Audit Objectives

Classification Amounts are properly classified

Cutoff

Transactions are recorded in the proper period

Account balances agree with master file amounts, and with the general ledger
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Detail tie-in

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

General Balance-related Audit Objectives

Realizable value Assets are included at estimated realizable value Assets must be owned

Rights and obligations

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Management Assertions and Transaction-related Audit Objectives

Hillsburg Hardware Company: As Applied to Inventory
Management Assertions About Account Balances General Balance- Specific Balance-related Audit related Audit Objectives Applied to Inventory Objectives

Existence Completeness

Existence Completeness

All recorded inventory exists at the balance sheet date All existing inventory has been counted and included in the inventory summary

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Management Assertions and Transaction-related Audit Objectives

Hillsburg Hardware Company: As Applied to Inventory
Management Assertions About Account Balances General Balance- Specific Balance-related Audit related Audit Objectives Applied to Inventory Objectives

Valuation and allocation

Accuracy

Inventory quantities on the clients 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
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2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Management Assertions and Transaction-related Audit Objectives

Hillsburg Hardware Company: As Applied to Inventory
Management Assertions About Account Balances General Balance- Specific Balance-related Audit related Audit Objectives Applied to Inventory Objectives

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
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2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Management Assertions and Transaction-related Audit Objectives

Hillsburg Hardware Company: As Applied to Inventory
Management Assertions About Account Balances General Balance- Specific Balance-related Audit related Audit Objectives Applied to Inventory Objectives

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 The company has title to all inventory items listed Inventories are not pledged as collateral
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Rights and obligations Rights and obligations

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Learning Objective 9
Link the four presentation and disclosure-related audit objectives to management assertions for presentation and disclosure.

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Management Assertions and Presentation and Disclosure-related Audit Objectives

Hillsburg Hardware Company: As Applied to Notes Payable
Management Assertions About Presentation and Disclosure General Presentationand Disclosurerelated Audit Objectives Specific Presentation and Disclosure-related Audit Objectives Applied to Notes Payable

Occurrence and rights and obligations Completeness

Occurrence and rights and obligations Completeness

Notes payable as described in the footnotes exist and are obligations of the company All required disclosures related to notes payable are included in the financial statement footnotes
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2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

Management Assertions and Presentation and Disclosure-related Audit Objectives

Hillsburg Hardware Company: As Applied to Notes Payable
Management Assertions About Presentation and Disclosure General Presentationand Disclosurerelated 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 Classification Notes payable are appropriately and and classified as to short-term and understandability understandability long-term obligations and related financial statement disclosures are understandable
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Learning Objective 10
Explain the relationship between audit objectives and the accumulation of audit evidence.

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How Audit Objectives Are Met

The auditor must obtain sufficient appropriate audit evidence to support all management assertions in the financial statements. An audit process has four specific phases

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Four Phases of a Financial Statement Audit

Plan and design Phase I an audit approach
Perform analytical procedures and Phase III tests of details of balances

Phase II

Perform tests of controls and substantive tests of transactions

Complete the Phase IV audit and issue an audit report

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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End of Chapter 6

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder

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