©2010 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6 - 1 Audit Responsibilities and Objectives Chapter 6

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 6 - 1

Audit ResponsibilitiesAudit Responsibilitiesand Objectivesand Objectives

Chapter 6Chapter 6

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 13/e,Auditing 13/e, Arens/Elder/Beasley Arens/Elder/Beasley 6 - 6 - 22

Learning Objective 1Learning Objective 1

Explain the objective ofExplain the objective of

conducting an audit ofconducting an audit of

financial statements andfinancial statements and

an audit of internal controls.an audit of internal controls.


Objective of Conducting an Objective of Conducting an Audit of Financial StatementsAudit of Financial Statements

The objective of the ordinary audit of financialstatements is the expression of an opinion ofthe fairness with which they present fairly, inall respects, financial position, result ofoperations, and its cash flows inconformity with GAAP.


Steps to Develop Audit Steps to Develop Audit Objectives Objectives


Steps to Develop Audit Steps to Develop Audit ObjectivesObjectives

4. Know general audit objectives forclasses of transactions and accounts.

5. Know specific audit objectives forclasses of transactions, accounts and

disclosures.



Distinguish management’sDistinguish management’s

responsibility for the financialresponsibility for the financial

statements and internal controlstatements and internal control

from the auditor’s responsibilityfrom the auditor’s responsibility

for verifying the financialfor verifying the financial

statements and effectivenessstatements and effectiveness

of internal control.of internal control.


Management’s ResponsibilitiesManagement’s Responsibilities

Management is responsible for the financialstatements and for internal control.

The Sarbanes-Oxley Act increases management’sresponsibility for the financial statements.

It requires the CEO and the CFO of publiccompanies to certify the quarterly and annualfinancial statements submitted to the SEC.


Management’s ResponsibilitiesManagement’s Responsibilities

The Sarbanes-Oxley Act provides for criminalpenalties for anyone who knowingly falselycertifies the statements.



Explain the auditor’sExplain the auditor’s

responsibility for discoveringresponsibility for discovering

material misstatements.material misstatements.


Auditor’s ResponsibilitiesAuditor’s Responsibilities

Material versus immaterial misstatements

Reasonable assurance

Errors versus fraud

Professional skepticism

Fraud resulting from fraudulent financialreporting versus misappropriation of assets


Auditor’s Responsibilities for Auditor’s Responsibilities for Discovering Illegal ActsDiscovering Illegal Acts

Direct-effect illegal acts

Indirect-effect illegal acts

Evidence accumulation when there is no reasonto believe indirect-effect illegal act exists


Auditor’s Responsibilities for Auditor’s Responsibilities for Discovering Illegal ActsDiscovering Illegal Acts

Evidence accumulation and other actionswhen there is reason to believe direct- orindirect-effect illegal acts may exist

Actions when the auditor knows of an illegal act



Classify transactions and accountClassify transactions and account

balances into financial statementbalances into financial statement

cycles and identify benefits of acycles and identify benefits of a

cycle approach to segmentingcycle approach to segmenting

the audit.the audit.


Financial Statements CyclesFinancial Statements Cycles

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


Transaction Flow ExampleTransaction Flow ExampleLedgers,

Trial Balance,and FinancialStatements

General ledgerand subsidiary

records

General ledgertrial balance

Financialstatements

Acquisitionof goods

and services

Sales

Cashreceipts

Transactions

Cash receiptsjournal

Salesjournal

Acquisitionsjournal

Journals


Transaction Flow ExampleTransaction Flow Example

Allocationand

adjustments

Cashdisbursements

Payrollservices and

disbursements

Ledgers,Trial Balance,and FinancialStatements

General ledgerand subsidiary

records

General ledgertrial balance

Financialstatements

Transactions

Payrolljournal

Cashdisbursements

journal

Generaljournal

Journals


Relationships Among Relationships Among Transaction CyclesTransaction Cycles

Generalcash

Capital acquisitionand repayment cycle

Sales andcollection

cycle

Acquisitionand payment

cycle

Payroll andpersonnel

cycle

Inventory andwarehousing

cycle



Describe why the auditor obtainsDescribe why the auditor obtains

a combination of assurance bya combination of assurance by

auditing classes of transactionsauditing classes of transactions

and ending balances in accounts,and ending balances in accounts,

including presentation andincluding presentation and

disclosure.disclosure.


Balance and Transactions Balance and Transactions Affecting Balances ExampleAffecting Balances Example

Beginning balance

Sales

$ 17,521

$144,328 $137,087 Cash receipts

$ 1,242Sales returnsand allowances

Charge-off ofuncollectibleaccounts

Ending balance $ 20,197

$ 3,323

Accounts Receivable (in thousands)



Distinguish among the threeDistinguish among the three

categories of managementcategories of management

assertions about financialassertions about financial

information.information.


Management AssertionsManagement Assertions

1. Assertions about classes of transactions andevents for the period under audit

2. Assertions about account balances at period end

3. Assertions about presentation and disclosure


Management Assertions forManagement Assertions forEach Category of AssertionsEach Category of Assertions

Assertions About Classes Assertions About Classes of Transactions and Eventsof Transactions and Events

Assertions About Assertions About Account BalancesAccount Balances

Assertions About Assertions About Presentation and DisclosurePresentation and Disclosure

Occurrence Existence Occurrence and rightsand obligations

Completeness Completeness Completeness

Accuracy Valuation andallocation

Accuracy andvaluation

Classification Classification andunderstandability

Cutoff

Rights andobligations



Link the six general transaction-Link the six general transaction-

related audit objectives torelated audit objectives to

management assertionsmanagement assertions

for classes of transactions.for classes of transactions.


OccurrenceRecorded transactionsexist

CompletenessExisting transactionsare recorded

AccuracyRecorded transactionsare stated at thecorrect amounts

General Transactions-related General Transactions-related Audit ObjectivesAudit Objectives


ClassificationTransactions are properlyclassified.

TimingTransactions are recordedon the correct dates.

Posting andsummarization

Transactions are includedin the master files andare correctly summarized.

General Transactions-related General Transactions-related Audit ObjectivesAudit Objectives


Management AssertionsManagement AssertionsAbout Classes ofAbout Classes ofTransactions and EventsTransactions and Events

General Transaction-General Transaction-related Auditrelated AuditObjectivesObjectives

Specific Sales Transaction-Specific Sales Transaction-related Audit Objectivesrelated Audit Objectives

Occurrence Occurrence Recorded sales are forshipments made tononfictitious customers

Completeness Completeness Existing salestransactions are recorded

Accuracy Accuracy Recorded sales are forthe amount of goodsshipped and are correctlybilled and recorded

Hillsburg Hardware Co.Hillsburg Hardware Co.(Applied to Sales Transactions)


Accuracy Posting andsummarization

Sales transactions areproperly included in themaster file and arecorrectly summarized

Classification Classification Sales transactions areproperly classified

Cutoff Timing Sales transactions arerecorded on the correctdates.

General Transaction-General Transaction-related Auditrelated AuditObjectivesObjectives

Management AssertionsManagement AssertionsAbout Classes ofAbout Classes ofTransactions and EventsTransactions and Events

Specific Sales Transaction-Specific Sales Transaction-related Audit Objectivesrelated Audit Objectives

Hillsburg Hardware Co.Hillsburg Hardware Co.(Applied to Sales Transactions)



Link the eight general balance-Link the eight general balance-

related audit objectives torelated audit objectives to

management assertionsmanagement assertions

for account balances.for account balances.


Existence Amounts included exist

CompletenessExisting amounts areincluded

AccuracyAmounts included arestated at the correctamounts

General Balance-relatedGeneral Balance-relatedAudit ObjectivesAudit Objectives


ClassificationAmounts are properlyclassified

CutoffTransactions are recordedin the proper period

Detail tie-inAccount balances agreewith master file amounts,and with the general ledger



Realizablevalue

Assets are included atestimated realizable value

Rights andobligations

Assets must be owned



Management AssertionsManagement AssertionsAbout Account BalancesAbout Account Balances

General Balance-General Balance-related Auditrelated AuditObjectivesObjectives

Specific Balance-related AuditSpecific Balance-related AuditObjectives Applied to InventoryObjectives Applied to Inventory

Existence Existence All recorded inventory existsat the balance sheet date

Completeness Completeness All existing inventory hasbeen counted and includedin the inventory summary

Hillsburg Hardware Co.Hillsburg Hardware Co.(Applied to Inventory)




Valuation andallocation

Accuracy Inventory quantities on the client’s perpetual records agree with items physically on handPrices used to value inventories are materially correctExtensions of price times quantity are correct and details are correctly added







Classification

Cutoff

Inventory items are properly classified as to raw materials, work in process, and finished goodsPurchase cutoff at year end is properSales cutoff at year end is proper







Detail tie-in

Realizablevalue

Total of inventory items agrees with general ledgerInventories have been written down where net realizable value is impaired


Rights and obligations Rights andobligations

The company has title to all inventory items listedInventories are not pledged as collateral




Link the four presentation andLink the four presentation and

disclosure-related audit objectivesdisclosure-related audit objectives

to management assertions forto management assertions for

presentation and disclosure.presentation and disclosure.


ManagementManagementAssertions AboutAssertions AboutPresentation andPresentation andDisclosureDisclosure

Specific Presentation andSpecific Presentation andDisclosure-related Audit ObjectivesDisclosure-related Audit ObjectivesApplied to Notes PayableApplied to Notes Payable

Occurrenceand rights andobligations

Occurrenceand rights andobligations

Notes payable as described in thefootnotes exist and areobligations of the company

Completeness Completeness All required disclosures relatedto notes payable are included inthe financial statement footnotes

GeneralGeneralPresentation-Presentation-and Disclosure-and Disclosure-related Auditrelated AuditObjectivesObjectives

Hillsburg Hardware Co.Hillsburg Hardware Co.(Applied to Notes Payable)


ManagementManagementAssertions AboutAssertions AboutPresentation andPresentation andDisclosureDisclosure

Specific Presentation andSpecific Presentation andDisclosure-related Audit ObjectivesDisclosure-related Audit ObjectivesApplied to Notes PayableApplied to Notes Payable



Footnote disclosures related tonotes payable are accurate.

Classificationandunderstandability

Classificationandunderstandability

Notes payable are appropriatelyclassified as to short-term andlong-term obligations andrelated financial statementdisclosures are understandable

GeneralGeneralPresentation-Presentation-and Disclosure-and Disclosure-related Auditrelated AuditObjectivesObjectives

Hillsburg Hardware Co.Hillsburg Hardware Co.(Applied to Notes Payable)



Explain the relationship betweenExplain the relationship between

audit objectives and theaudit objectives and the

accumulation of audit evidence.accumulation of audit evidence.


How Audit Objectives Are MetHow Audit Objectives Are Met

The auditor must obtain sufficient appropriateaudit evidence to support all managementassertions in the financial statements.

An audit process has four specific phases


Four Phases of a Financial Four Phases of a Financial Statement AuditStatement Audit

Phase IPlan and designan audit approach

Phase II

Perform tests ofcontrols andsubstantive testsof transactions

Phase III

Perform analyticalprocedures andtests of detailsof balances

Phase IVComplete theaudit and issuean audit report

©2010 Prentice Hall Business Publishing, ©2010 Prentice Hall Business Publishing, Auditing 12/e,Auditing 12/e, Arens/Beasley/Elder Arens/Beasley/Elder 6 - 42

End of Chapter 6End of Chapter 6

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©2010 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6 - 1 Audit Responsibilities and Objectives Chapter 6