Audit Responsibilities and Objectives

1. Audit Responsibilitiesand Objectives Chapter 6

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

3. 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.

4. Understand objectives and responsibilities for the audit. 1 Divide financial statements into cycles. 2 Know management assertions about accounts. 3 Steps to Develop Audit Objectives

5. Know specific audit objectives for classes of transactions and accounts. 5 Steps to Develop Audit Objectives Know general audit objectives for classes of transactions and accounts. 4

6. Learning Objective 2 • Distinguish management’s • responsibility for the financial • statements and internal control • from the auditor’s responsibility • for verifying the financial • statements and effectiveness • of internal control.

7. 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.

8. Management’s Responsibilities The Sarbanes-Oxley Act provides for criminal penalties for anyone who knowingly falsely certifies the statements.

9. Learning Objective 3 • Explain the auditor’s • responsibility for discovering • material misstatements.

10. Auditor’s Responsibilities – Material versus immaterial misstatements – Reasonable assurance – Errors versus fraud – Professional skepticism – Fraud resulting from fraudulent financial reporting versus misappropriation of assets

11. 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

12. 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

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

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

15. 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 Transaction Flow Example

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

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

18. Learning Objective 5 • Describe why the auditor obtains • a combination of assurance by • auditing class of transactions and • ending balances in accounts.

19. 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 Balance and Transactions Affecting Balances Example

20. Learning Objective 6 • Distinguish among the five • categories of management • assertions about financial • information.

21. Management Assertions 1. Existence or occurrence 2. Completeness 3. Valuation or allocation 4. Rights and obligations 5. Presentation and disclosure

22. Learning Objective 7 • Link the six general transaction- • related audit objectives to the • five management assertions.

23. Management Assertions General Transaction- Related Audit Objectives Existence or occurrence Existence Completeness Completeness Valuation or allocation Accuracy Classification Timing Posting and summarization Rights and obligations N/A Presentation and disclosure N/A Transaction-Related Audit Objectives and Management Assertions

24. Existence Recorded transactions exist. Completeness Existing transactions are recorded. Accuracy Recorded transactions are stated at the correct amounts. Transaction-Related Audit Objectives and Management Assertions

25. Timing Transactions are recorded on the correct dates. Posting and summarization Transactions are included in the master files and are correctly summarized. Transaction-Related Audit Objectives and Management Assertions Classification Transactions are properly classified.

26. Learning Objective 8 • Link the nine general balance- • related audit objectives to the • five management assertions.

27. Management Assertions General Balance Related Audit Objectives Existence or occurrence Existence Completeness Completeness Valuation or allocation Accuracy Classification Cut-off, Detail tie-in Realizable value Rights and obligations Rights and obligations Presentation and disclosure Presentation and disclosure Assertions and Balance-Related Audit Objectives

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

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

30. Rights and obligations Assets must be owned. Presentation and disclosure Account balances and disclosures are presented in financial statements. General Balance-RelatedAudit Objectives Realizable value Assets are included at estimated realizable value.

31. Learning Objective 9 • Explain the relationship between • audit objectives and the • accumulation of audit evidence.

32. How Audit Objectives Are Met The auditor must obtain sufficient competent audit evidence to support all management assertions in the financial statements. An audit process is a methodology for organizing an audit.

33. 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. Four Phases of a Financial Statement Audit

34. End of Chapter 6