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77 terms

Chapter 6: Audit Responsibilities & Objectives

AU 110
Objective of the ordinary audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present , in all material respects, financial position, results of operations, and cash flows in conformity to GAAP.
Management's responsibility
is to adopt sound accounting policies, maintain adequate internal control, make fair representation in the financial statements
AU 110 amended
auditor has the responsibility to plan and perform audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. The auditor is able to obtain REASONABLE NOT absolute assurance that material misstatements are detected. The auditor has no responsibility to plan or perform the audit to obtain reasonable assurance, whether caused by error or fraud, that are not material to the financial statements are detected.
Material Misstatements
if the combined uncorrected errors and fraud in the financial statements would likely have changed or influenced the decision of a reasonable person using the statements.
The Auditor is Responsible for reasonable, but NOT ABSOLUTE, assurance for several reasons...
1. Most audit evidence results from TESTING A SAMPLE of a population. Sampling inevitably includes some risk of not uncovering a material misstatement.
2. Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events.
3.Fraudulently prepare financial statements are often extremely difficult for the auditor to detect
The auditor's best defense when material misstatements are not uncovered is
to have conducted the audit in accordance with auditing standards.
unintentional misstatement; auditor provides reasonable assurance
intentional misstatement; auditor provides reasonable assurance
3 Types of Fraud
1. Misappropriation of Assets
2. Fraudulent Financial Reporting
3. Illegal Acts
Misappropriation of Assets
defalcation or employee fraud; stealing; stockholders, creditors and others are harmed because assets are no longer available to their rightful owners.
Fraudulent Financial Reporting
management fraud; harms users by providing them incorrect financial statement info for their decision making
Professional Skepticism
is an attitude that includes a questioning mind and a critical assessment of audit evidence. Audit must be planned and performed with an attitude of professional skepticism in all aspects of the engagement.
Illegal Acts (AU 317)
violation of laws or govt regulations other than fraud.
Direct-Effect Illegal Acts
violations of laws & regulations that have a direct financial effect on specific account balances in the financial statements. You can trace numbers on financial statements directly. Auditor must evaluate whether or not there is evidence available to indicate material violations of federal or state tax law. REASONABLE ASSURANCE is provided
Indirect-Effect Illegal Acts
most illegal acts effect the financial statement only indirectly. Ex: material fines and sanctions from violating environmental protection laws, violations of insider securities trading regulations. Hard to trace. Auditors provide NO ASSURANCE that indirect-illegal acts will be detected.
Auditors have THREE levels of responsibility for finding and reporting illegal acts:
1. Evidence Accumulation When There is NO Reason to Believe Indirect-Effect Illegal Acts Exist
2. Evidence Accumulation & Other Actions When There IS REASON to Believe Direct or Indirect-Effect Illegal Acts May Exist
3. Actions When the Auditor KNOWS of an Illegal Act
Evidence Accumulation When There is NO Reason to Believe Indirect-Effect Illegal Acts Exist
if there is no indication that anything is wrong, conduct audit in the regular way. Auditor should ask management about policies established to prevent illegal acts. The auditor should NOT search for indirect-effect illegal acts unless there is reason to believe the may exist
Evidence Accumulation & Other Actions When There IS REASON to Believe Direct or Indirect-Effect Illegal Acts May Exist
1. inquire of management at a level above those likely to be involved in the potential illegal act
2. Consult with the client's legal counsel or other specialist who is knowledgeable about the illegal act
3.Consider accumulation additional evidence
Actions When the Auditor KNOWS of an Illegal Act
1. consider the effects on the financial statements, including adequacy of disclosures
2.consider the effect of such illegal acts on the CPA acts on the CPA's firm's relationship with management. Maybe withdraw from engagement.
3. communicate with the audit committee or others of equivalent authority to make sure that they know of the illegal act; oral or written communication
4. If the client is publicly held, the auditor must also report the matter directly to the SEC
Cycle Approach
1. Audits are performed by dividing the financial statements into smaller segments or components. The division makes the audit more manageable & aids in the assignment of tasks to diff member of the audit team.
2. After the audit of each segment is completed, including interrelationships with other segment, the results are combined. A conclusion can then be reached about the financial statements taken as a whole.
3. A common way to divide an audit is to keep closely related types (classes) of transactions and account balances in the same segment
Logic of the Cycle Approach
- ties to the way transactions are recorded in journals and summarized in the general ledger and financial statements.
Audit Cycles
1. Sales and collection
2. Acquisition and payment
3.Payroll and personnel
4. Inventory and warehousing
5. Capital acquisition and repayment
6. General Ledger/recording cycle
Trial Balance
used to prepare financial statements and is a primary focus of every audit
Part of 2 or more cycles
1. cash
2. inventory
Sales and collection cycle
is the 1stcyle listed and is a primary focus on most audits
Sales and Collection
Acquisition and Payment
expenditure and purchases
Payroll and Personnel
Inventory and Warehousing
WIP, DM, making the product
Capital Acquisition and repayment
selling stock and borrowing money
General Ledger/ Recording cycle
recording transactions
Overall Assurance Can Be Increase in Almost All Audits By
Auditing the ending balance in accounts receivable.
The most efficient and effective way to conduct audits is to obtain
some combo of assurance for each class of transactions and for the ending balance in the related accounts.
Transaction-related audit objectives
For any given class of transactions, several audit objectives must be met before the auditor can conclude that the transactions are properly recorded
Balance-related audit objectives
several audit objectives must be met for each account balance
Presentation and disclosure related audit objectives
relates to the presentation and disclosure of information in the financial statements
Management Assertions
-implied or expressed representations by management about classes of transactions and the related accounts and disclosures in the financial statements. In most cases they are implied.
-These assertions apply to classes of transaction, account balances, and presentation disclosures.
Management assertions are directly related to
Audit Assertion Categories (AU 326)
1. classes of transactions & events for the period under audit
2. account balances at period end
3. presentation and disclosure
Assertions about classes of transactions & events
1. Occurrence
2. Completeness
3. Accuracy
4. Classification
5. Cutoff
Assertions about account balances
1. Existence
2. Completeness
3. Valuation and Allocation
4. Rights and Obligations
Assertions about presentation and disclosure
1. Occurrence and rights and obligation
2. Completeness
3. Accuracy and Valuation
4. Classification and Understandability
Occurrence (T&E)
transaction and events that HAVE been recorded have occurred and pertain to the entity
Completeness (T&E)
all transactions and events that should have been recorded have been recorded
Accuracy (T&E)
amounts and other data relating to recorded transactions and events have been recorded appropriately
Classification (T&E)
Transactions & events have been recorded in the proper accounts
Cutoff (T&E)
transactions & events have been recorded in the correct accounting period
Existence (AB)
Assets, liabilities, and equity interests exist
Completeness (AB)
all assets, liabilities and equity interests that should have been recorded have been recorded
Valuation and allocation (AB)
assets, liabilities, and equity interest are included in the financial statements at appropriate amounts and any resulting valuation adjustments are appropriately recorded
Rights and obligations (AB)
the entity holds or controls the rights to assets and liabilities are the obligation of the entity
Occurrence and rights and obligations (P&D)
disclosed events and transactions have occurred and pertain to the entity
Completeness (P&D)
all disclosures that should have been included in the financial statements have been included
Accuracy and Valuation (P&D)
financial and other information are disclosed appropriately and at appropriate amounts
Classification & Understandability (P&D)
financial and other information is appropriately presented and described and disclosures are clearly expressed
Relevant Assertions
- auditor should consider the relevance of ea assertion for ea significant class of transactions, account balance, and presentation disclosure
- have a meaningful bearing on whether account is fairly stated and are used to assess the risk of material misstatement and the design and performance of audit procedures
Transaction Related Audit Objectives
Posting and Summarization
Occurrence (T&E-AO)
recorded sales are for shipments made to nonfictitious customers.
Completeness (T&E-AO)
existing sales transactions are recorded
Accuracy (T&E-AO)
Recorded sales are for the amount of goods shipped & are correctly billed and recorded
Posting and summarization (T&E-AO)
sales transactions are properly included in the master file and are correctly summarized
Classification (T&E-AO)
sales transactions are properly classified
Timing (T&E-AO)
sales transactions are recorded on the corrected dates
Balance Related Audit Objectives
Rights and Obligations
Detail tie-in

Realization Value
Existence (AB-AO)
all recorded inventory exists at the balance sheet date
Completeness (AB-AO)
all existing inventory has been counted and included in the inventory summary
Accuracy (AB-AO)
inventory quantities on the client's perpetual records agree with items physically on hand
Classification (AB-AO)
inventory items are properly classified as to RM, AIP, and FG
Cutoff (AB-AO)
Purchase cutoff at year-end is proper. Sales cutoff at year-end is proper.
Detail tie-in (AB-AO)
Total inventory items agrees with general ledger
Realizable value (AB-AO)
Inventories have been written down where net realizable value is impaired
Rights and obligations (AB-AO)
The company has title to all inventory items listed. Inventories are not pledged as collateral
Presentation and Disclosure Related Audit Objectives
Classification and understandability
Occurrence and rights and obligations
Allocation and valuation
Occurrence and right and obligations (DR-AO)
notes payable as described in the footnotes exist and are obligations of the company.
Completeness (DR-AO)
All required disclosures related to notes payable are included in the financial statement footnotes
Valuation and allocation (DR-AO)
Footnote disclosures related to notes payable are accurate.
Classification and Understandability (DR-AO)
Notes payable are appropriately classified as to short-term and long-term obligations and related financial statement disclosures are understandable.