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CHAPTER 5Audit

Responsibilitiesand Objectives

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What is the What is the objectiveobjective of an audit? of an audit?

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What is the What is the objectiveobjective of an audit? of an audit?

An expression of opinionon the fair presentation of the financial statements in

accordance with GAAP.

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Regarding financial reporting, what are Regarding financial reporting, what are management’smanagement’s responsibilities? responsibilities?

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Regarding financial reporting, what are Regarding financial reporting, what are management’smanagement’s responsibilities? responsibilities?

- adopting sound accounting policies

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Regarding financial reporting, what are Regarding financial reporting, what are management’smanagement’s responsibilities? responsibilities?

- adopting sound accounting policies- maintaining adequate internal controls

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Regarding financial reporting, what are Regarding financial reporting, what are management’smanagement’s responsibilities? responsibilities?

- adopting sound accounting policies- maintaining adequate internal controls- ensuring fairness of financial statements

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These responsibilities may be specifiedThese responsibilities may be specifiedin a in a

Management ReportManagement Report..

?

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- typically includes statements regarding management’s responsibility for inter- nal controls and financial statements

These responsibilities may be specifiedThese responsibilities may be specifiedin a in a

Management ReportManagement Report..

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- typically includes statements regarding management’s responsibility for inter- nal controls and financial statements- explains operations of audit committee and Board of Directors

These responsibilities may be specifiedThese responsibilities may be specifiedin a in a

Report of Management’s ResponsibilityReport of Management’s Responsibility..

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- typically includes statements regarding management’s responsibility for inter- nal controls and financial statements- explains operations of audit committee and Board of Directors- is signed by client management and in- cluded in the company’s annual report

These responsibilities may be specifiedThese responsibilities may be specifiedin a in a

Report of Management’s ResponsibilityReport of Management’s Responsibility..

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- typically includes statements regarding management’s responsibility for inter- nal controls and financial statements- explains operations of audit committee- is signed by client management and in- cluded in the company’s annual report- not required but requested by auditor

These responsibilities may be specifiedThese responsibilities may be specifiedin a in a

Report of Management’s ResponsibilityReport of Management’s Responsibility..

WHY?WHY?

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What are the What are the auditors’auditors’ responsibilities? responsibilities?

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What are the What are the auditors’auditors’ responsibilities? responsibilities?

- performing audit and completing report in accordance with GAAS

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What are the What are the auditors’auditors’ responsibilities? responsibilities?

- performing audit and completing report in accordance with GAAS- designing the audit to provide reason- able assurance of detecting fraud, errors & irregularities that are material

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There is There is much confusionmuch confusion among among the investing public regarding the investing public regarding

auditor responsibilities.auditor responsibilities.

I thoughtauditorslooked at

every bit ofevidence andrecalculatedeverything!

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There is There is much confusionmuch confusion among among the investing public regarding the investing public regarding

auditor responsibilities.auditor responsibilities.

Auditors are responsible for designing the audit to detect material misstate-ments (which include fraud, errorsand irregularities).

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There is There is much confusionmuch confusion among the among the investing public regarding auditor investing public regarding auditor

responsibilities.responsibilities.

BUTBUT

Auditors are not responsible for finding all material fraud & other irregularities.

Auditors are responsible for designing the audit to detect material misstate-ments (which include fraud, errors& irregularities).

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Could auditors Could auditors guaranteeguarantee that that everyevery material fraud, error & material fraud, error & irregularity was detected?irregularity was detected?

Guarantee

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Could auditors Could auditors guarantee guarantee that that everyevery material error, fraud & material error, fraud & irregularity was detected?irregularity was detected?

PerhapsPerhaps, through a 100% audit (no samples) which would require:

an army of auditors and enormous audit fees.

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What is the difference between What is the difference between fraudfraud and an and an illegal actillegal act??

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fraud - individual(s) within the client organization acting against the client organization

What is the difference between What is the difference between fraudfraud and an and an illegal actillegal act??

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fraud - individual(s) within the client organization acting against the client organization

illegal act - intentional violation of law by the client organization

What is the difference between What is the difference between fraudfraud and an and an illegal actillegal act??

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Why is auditor detection of fraud Why is auditor detection of fraud difficult?difficult?

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- the auditor’s knowledge of client internal controls may be inferior to that of employees

Why is auditor detection of fraud Why is auditor detection of fraud difficult?difficult?

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- the auditor’s knowledge of client internal controls may be inferior to that of employees- the fraud will be intentionally concealed

Why is auditor detection of fraud Why is auditor detection of fraud difficult?difficult?

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- the auditor’s knowledge of client internal controls may be inferior to that of employees- the fraud will be intentionally concealed- client management may have the ability to override internal controls

Why is auditor detection of fraud Why is auditor detection of fraud difficult?difficult?

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The The likelihood of fraudlikelihood of fraud may be detected may be detectedin the evaluation of internal controls:in the evaluation of internal controls:

weak internal controls = greater risk of fraud

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What are the auditors’ responsibilities What are the auditors’ responsibilities regarding client regarding client illegal actsillegal acts??

violations of environmental laws, for example?

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The auditor must provide reasonableassurance of detection of illegal

acts that have a direct effecton the financial statements.

What are the auditors’ responsibilities What are the auditors’ responsibilities regarding client regarding client illegal actsillegal acts??

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The auditor must provide reasonableassurance of detection of illegal

acts that have a direct effecton the financial statements.

The auditor provides noassurance of detection of illegalacts that have an indirect effect

on the financial statements.

What are the auditors’ responsibilities What are the auditors’ responsibilities regarding client regarding client illegal actsillegal acts??

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Regarding Regarding illegal actsillegal acts, auditors , auditors should, in should, in allall audits, audits,

- read minutes of board meetings

Minutes ofBoard of Directors’

Meetings

Ace Company

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- read minutes of board meetings- enquire of client’s lawyers

Regarding Regarding illegal actsillegal acts, auditors , auditors should, in should, in allall audits, audits,

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- read minutes of board meetings- enquire of client’s lawyers- enquire of client management regarding the occurrence of illegal acts AND client policies regarding illegal acts

Regarding Regarding illegal actsillegal acts, auditors , auditors should, in should, in allall audits, audits,

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What should auditors do if theysuspect

that an illegal act has occurred?

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- enquire of client management at a level above those involved

What should auditors do ifWhat should auditors do ifthey they suspectsuspect that an illegal that an illegal

act has occurred?act has occurred?

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- enquire of client management at a level above those involved

- consult with client’s lawyer oranother specialist

What should auditors do ifWhat should auditors do ifthey they suspectsuspect that an illegal that an illegal

act has occurred?act has occurred?

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- enquire of client management at a level above those involved

- consult with client’s lawyer oranother specialist

- gather evidence regarding theillegal act

What should auditors do ifWhat should auditors do ifthey they suspectsuspect that an illegal that an illegal

act has occurred?act has occurred?

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What should auditors do if they knowthat an illegal act has occurred?

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- consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification

What should auditors do ifWhat should auditors do ifthey they knowknow that an illegal that an illegal

act has occurred?act has occurred?

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- consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification- consider client management integrity; consult with lawyer; withdraw if appropriate

What should auditors do ifWhat should auditors do ifthey they knowknow that an illegal that an illegal

act has occurred?act has occurred?

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- consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification- consider client management integrity; consult with lawyer; withdraw if appropriate- inform audit committee or others

What should auditors do ifWhat should auditors do ifthey they knowknow that an illegal that an illegal

act has occurred?act has occurred?

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- consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification- consider client management integrity; consult with lawyer; withdraw if appropriate- inform audit committee or others

What should auditors do ifWhat should auditors do ifthey they knowknow that an illegal that an illegal

act has occurred?act has occurred?

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EE

Inan audit

engagement,where doesthe auditor

start?

TTNN

CCLLII

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Would it make sense to startwith the financial statements and

audit each line item?

Inan audit

engagement,where doesthe auditor

start?

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A better approach would be to grouptogether similar accounts and audit

each group (cycle approach).

NO! grossly inefficientgrossly inefficient

Would it make sense to startwith the financial statements and

audit each line item?

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financial statements

financial statement cycles

management assertions

general auditobjectives

specific auditobjectives

the cycleapproach

audittests

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financial statements

financial statement cycles

the cycleapproach

What transaction cyclesand groups of accounts are

relevant to this particular client?

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financial statements

financial statement cycles

management assertions

the cycleapproach

What is client’s management“asserting” about the statements,

cycles, and internal controls?

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Management assertionsManagement assertions

- existence or occurrence - financial components exist at a given date, transactions have occurred during a given period

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- existence or occurrence - completeness - all transactions and accounts are presented, nothing has been left out

Management assertionsManagement assertions

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- existence or occurrence - completeness- valuation or allocation - com- ponents of financial statements are included at appropriate amounts

Management assertionsManagement assertions

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MortgageAgreement

Property

Deed

- existence or occurrence - completeness- valuation or allocation - rights and obligations - assets are rights of the entity and liabilities are obligations

Management assertionsManagement assertions

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- existence or occurrence - completeness - rights and obligations - valuation or allocation - presentation and disclosure - financial statement components are properly classified, de- scribed, and disclosed

Management assertionsManagement assertions

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}

financial statements

financial statement cycles

management assertions

general auditobjectives

the cycleapproach

Audit evidence must be

gathered to support/refute management assertions.

specific auditobjectives

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Transaction-related Audit ObjectivesTransaction-related Audit Objectives

related tomanagement

assertions

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Transaction-related Audit ObjectivesTransaction-related Audit Objectives

- existence

Did recordedDid recordedtransactionstransactions

actually occur?actually occur?

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Transaction-related Audit ObjectivesTransaction-related Audit Objectives- existence- completeness

Have allHave alltransactionstransactions

been recorded?been recorded?

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Transaction-related Audit ObjectivesTransaction-related Audit Objectives

- existence- completeness- accuracy

Are recorded trans-Are recorded trans-actions stated at theactions stated at the

correct amounts?correct amounts?

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Transaction-related Audit ObjectivesTransaction-related Audit Objectives- existence- completeness- accuracy- classification

Are transactionsAre transactionsproperlyproperly

classified?classified?

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Transaction-related Audit ObjectivesTransaction-related Audit Objectives- existence- completeness- accuracy- classification- timing

Are transactionsAre transactionsrecorded on therecorded on thecorrect dates?correct dates?

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Transaction-related Audit ObjectivesTransaction-related Audit Objectives- existence- completeness- accuracy- classification- timing- posting and summarization

Are recorded Are recorded transactionstransactions

properly included properly included in the accountingin the accounting

records and records and correctly correctly

summarized?summarized?

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Balance-related Audit ObjectivesBalance-related Audit Objectives

alsorelated to

managementassertions

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Balance-related Audit ObjectivesBalance-related Audit Objectives- existence

Do amountsDo amountsincluded in theincluded in the

financial statementsfinancial statementsactually exist?actually exist?

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Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness

Have Have allall amounts that amounts thatshould have been in-should have been in-

cluded in the financialcluded in the financialstatements actuallystatements actually

been included?been included?

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Are financial state-Are financial state-ment balances in-ment balances in-

cluded at the correctcluded at the correctarithmetic amounts?arithmetic amounts?

Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness- accuracy

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Are amounts properlyAre amounts properlyclassified in theclassified in the

correct accounts?correct accounts?

Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness- accuracy- classification

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Are transactions near theAre transactions near thebalance sheet date recordedbalance sheet date recorded

in the proper period?in the proper period?

Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness- accuracy- classification- cutoff

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Do details in Do details in account balances account balances agree with other agree with other

related accounting related accounting information?information?

Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness- accuracy- classification- cutoff- detail tie-in

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When When appropriate, appropriate, are assets are assets

included in the included in the financial financial

statements at statements at realizable realizable

value?value?

Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness- accuracy- classification- cutoff- detail tie-in- realizable value

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Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness- accuracy- classification- cutoff- detail tie-in- realizable value- rights and obligations

Do liabilities Do liabilities represent represent

actual actual obligations?obligations?

Are assets Are assets owned?owned?

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Balance-related Audit ObjectivesBalance-related Audit Objectives- existence- completeness- accuracy- classification- cutoff- detail tie-in- realizable value- rights and obligations- presentation and disclosure

Are account Are account balances and balances and

related related disclosures disclosures

properly properly presented in presented in the financial the financial statements?statements?

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financial statements

financial statement cycles

management assertions

general auditobjectives

the cycleapproach

How doesan auditor address

thespecific auditobjectives?

specific auditobjectives

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financial statements

financial statement cycles

management assertions

general auditobjectives

specific auditobjectives

the cycleapproach

obtain sufficient

appropriate audit evidence

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An audit can be divided into An audit can be divided into four four phasesphases..

I II

III IV

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An audit can be divided into An audit can be divided into four four phasesphases..

II

III IV

I. Plan and designan audit approach.

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An audit can be divided into An audit can be divided into four four phasesphases..

III IV

I. Plan and designan audit approach.

II. Perform testsof controls.

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An audit can be divided into An audit can be divided into four four phasesphases..

II. Perform testsof controls.

What aretests of controls?

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An audit can be divided into An audit can be divided into four four phasesphases..

II. Perform testsof controls .

Tests of controls examine the effective-

ness of internal controls.

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An audit can be divided into An audit can be divided into four four phasesphases..

I. Plan and designan audit approach.

II. Perform testsof controls.

III. Perform analyt-ical procedures and

tests of details ofbalances.

IV

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An audit can be divided into An audit can be divided into four four phasesphases..

III. Perform analyt-ical procedures and

tests of details ofbalances.

Whatare analyticalprocedures?

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An audit can be divided into An audit can be divided into four four phasesphases..

III. Perform analyt-ical procedures and

tests of details ofbalances.

Analytical proceduresuse comparisons and relation-ships to determine reasonable-

ness of transactions and balances.

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An audit can be divided into An audit can be divided into four four phasesphases..

III. Perform analyt-ical procedures and

tests of details ofbalances.

Whatare tests of details

of balances?

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An audit can be divided into An audit can be divided into four four phasesphases..

III. Perform analyt-ical procedures and

tests of details ofbalances.

Tests of detailsof balances examine monetary

errors and irregularities indetails of financial statements.

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An audit can be divided into An audit can be divided into four four phasesphases..

I. Plan and designan audit approach.

II. Perform testsof controls.

III. Perform analyt-ical procedures and

tests of details ofbalances.

IV. Complete theaudit and issue an

audit report.