Developing Audit Objectives: Financial Statement Assertions

1. Audit Responsibilitiesand Objectivesمسؤولية واهداف التدقيق Chapter 6

2. 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.

3. 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.

4. 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.

5. Management’s Responsibilities Management is responsible for the financial statements and for internal control. The Sarbanes-Oxley Act increases management’s 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.

6. Auditor’s Responsibilities • Material versus immaterial misstatements responsible that material misstatements are detected • Reasonable assurance • Errors versus fraud • Professional skepticism • Fraud resulting from fraudulent financial reporting versus misappropriation of assets

7. Auditor’s 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

8. Auditor’s 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

9. Financial Statements Cycles Audits are performed by dividing the financial statements into smaller segments or components.

10. Transaction Flow Example Ledgers, Trial Balance, and Financial Statements Transactions Journals Sales Sales journal General ledger and subsidiary records Cash receipts Cash receipts journal General ledger trial balance Acquisition of goods and services Acquisitions journal Financial statements

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

12. Relationships Among Transaction Cycles General cash Capital acquisition and repayment cycle Sales and collection cycle Acquisition and payment cycle Payroll and personnel cycle Inventory and warehousing cycle

13. Balance and Transactions Affecting Balances Example Accounts Receivable (in thousands) Beginning balance $ 17,521 Sales $144,328 $137,087 Cash receipts $ 1,242 Sales returns and allowances $ 3,323 Charge-off of uncollectible accounts Ending balance $ 20,197

14. Management Assertions • 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

15. Management Assertions forEach Category of Assertions Assertions About Classes of Transactions and Events Assertions About Account Balances Assertions About Presentation and Disclosure Occurrence Existence Occurrence and rights and obligations Completeness Completeness Completeness Accuracy Valuation and allocation Accuracy and valuation Classification Classification and understandability Cutoff Rights and obligations

16. General Transactions-related Audit Objectives Occurrence Recorded transactions exist Completeness Existing transactions are recorded Accuracy Recorded transactions are stated at the correct amounts

17. General Transactions-related Audit Objectives Posting and summarization Transactions are included in the master files and are correctly summarized. Classification Transactions are properly classified. Timing Transactions are recorded on the correct dates.

18. Management Assertions andTransaction-related Audit Objectives Hillsburg Hardware Company: As Applied to Sales Transactions Management Assertions About Classes of Transactions and Events General Transaction- related Audit Objectives Specific Sales Transaction- related Audit Objectives Occurrence Occurrence Recorded sales are for shipments made to nonfictitious customers Completeness Completeness Existing sales transactions are recorded Accuracy Accuracy Recorded sales are for the amount of goods shipped and are correctly billed and recorded

19. Management Assertions andTransaction-related Audit Objectives Hillsburg Hardware Company: As Applied to Sales Transactions Management Assertions About Classes of Transactions and Events General Transaction- related Audit Objectives Specific Sales Transaction- related Audit Objectives Accuracy Posting and summarization Sales transactions are properly included in the master file and are correctly summarized Classification Classification Sales transactions are properly classified Cutoff Timing Sales transactions are recorded on the correct dates.

20. General Balance-relatedAudit Objectives Existence Amounts included exist Completeness Existing amounts are included Accuracy Amounts included are stated at the correct amounts

21. General Balance-relatedAudit Objectives Classification Amounts are properly classified Cutoff Transactions are recorded in the proper period Detail tie-in Account balances agree with master file amounts, and with the general ledger

22. General Balance-relatedAudit Objectives Realizable value Assets are included at estimated realizable value Rights and obligations Assets must be owned

23. Management Assertions andTransaction-related Audit Objectives Hillsburg Hardware Company: As Applied to Inventory Management Assertions About Account Balances General Balance- related Audit Objectives Specific Balance-related Audit Objectives Applied to Inventory Existence Existence All recorded inventory exists at the balance sheet date Completeness Completeness All existing inventory has been counted and included in the inventory summary

24. Management Assertions andTransaction-related Audit Objectives Hillsburg Hardware Company: As Applied to Inventory Management Assertions About Account Balances General Balance- related Audit Objectives Specific Balance-related Audit Objectives Applied to Inventory Valuation and allocation Accuracy Inventory quantities on the client’s 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

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

26. Management Assertions andTransaction-related Audit Objectives Hillsburg Hardware Company: As Applied to Inventory Management Assertions About Account Balances General Balance- related Audit Objectives Specific Balance-related Audit Objectives Applied to Inventory 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 Rights and obligations Rights and obligations The company has title to all inventory items listed Inventories are not pledged as collateral

27. Management Assertions and Presentation and Disclosure-related Audit Objectives Hillsburg Hardware Company: As Applied to Notes Payable Management Assertions About Presentation and Disclosure General Presentation- and Disclosure- related Audit Objectives Specific Presentation and Disclosure-related Audit Objectives Applied to Notes Payable Occurrence and rights and obligations Occurrence and rights and obligations Notes payable as described in the footnotes exist and are obligations of the company Completeness Completeness All required disclosures related to notes payable are included in the financial statement footnotes

28. Management Assertions and Presentation and Disclosure-related Audit Objectives Hillsburg Hardware Company: As Applied to Notes Payable Management Assertions About Presentation and Disclosure General Presentation- and Disclosure- related 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 and understandability Classification and understandability Notes payable are appropriately classified as to short-term and long-term obligations and related financial statement disclosures are understandable

29. 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

30. Four Phases of a Financial Statement Audit Phase I Plan and design an audit approach Phase III Perform analytical procedures and tests of details of balances Phase II Perform tests of controls and substantive tests of transactions Phase IV Complete the audit and issue an audit report

31. End of Chapter 6