Audit Objective

1. Audit Objective Primary objective of the audit is to express an opinion on the financial statements • Other objectives are secondary

2. Management vs. Auditor Responsibilities • Management • Financial statements • Internal controls Auditor Issue opinion on fairness of financial statements (and effectiveness of controls if a public company)

3. Objective of Audit • Issue Opinion on Financial Statements • Other objectives are secondary • Provides reasonable assurance f/s are free from material misstatement • Audit performed with professional skepticism

4. The Best Auditors Come From This State

5. Sources of material misstatements in financial statements: Errors - Unintentional misstatement of F/S Fraud - Intentional misstatement

6. Fraud • Fraudulent financial reporting • Misappropriation of assets • Illegal acts • Direct effect • Indirect effect What are some management incentives to misstate income?

7. Campbell Soup Case Talking points • Ownership control • Objectives of fraud? • How accomplished? • Why were auditors not found guilty?

8. Auditor Responsibility Auditor provides reasonable assurance of detecting material • errors • fraud (SAS #99) • direct effect illegal acts (no responsibility for indirect effects) Comparatively few frauds are detected by auditors –why?

9. Prevention/Detection of Frauds KPMG 2003

10. The Fraud Triangle Incentives/Pressures Opportunities Attitudes/Rationalization

11. SAS 99 on Fraud • Focus on the “fraud triangle” by major fraud types • Misappropriation of assets • Fraudulent financial reporting • Auditors’ primary concern is fraudulent reporting • Cannot ignore misappropriation of assets • Material in some cases • Often accompanies fraudulent financial reporting • Source of expectation gap • Misappropriations are best prevented by appropriate controls

12. MC 6-20 (b) What assurance does the auditor provide that errors, fraud and direct-effect illegal acts that are material to the financial statements will be detected? Direct-effect Errors Fraud Illegal Acts 1. Limited Negative Limited 2. Reasonable Reasonable Reasonable 3. Limited Limited Reasonable 4. Reasonable Limited Limited

13. Overview of Three Classes of Assertions Class Account Presentation & Of TransBalancesDisclosure Occurrence Existence Occurrence/Rights Completeness CompletenessCompleteness Accuracy Valuation/ Accuracy/ Allocation Valuation Classification Classification/ Understandability Cutoff Rights/Obligations

14. Occurrence/Existence vs. Completeness • Occurrence/Existence • Concerned with recorded amounts • Primarily concerned with overstatements • Completeness • Concerned with omitted amounts or transactions • Primarily concerned with understatements

15. An auditor would most likely analyze inventory turnover rates to obtain evidence concerning management’s assertions about: 1. Existence or occurrence 2. Rights and obligations 3. Valuation or allocation 4. Presentation and disclosure

16. Transaction and Balance Objectives • Transaction objectives - apply to classes of transactions recorded throughout the year • Balance objectives - Apply to ending balances in accounts • Primary emphasis is balance sheet accounts

17. Assertion Trans. Objective Occurrence Occurrence Completeness Completeness Accuracy Valuation or Classification Allocation Timing Posting & Summ. Rights & Oblig. N/A

18. Assertion Balance Objective Existence Existence Completeness Completeness Accuracy Valuation or Classification Allocation Cutoff Detail tie-in Realizable Value Rights & Oblig. Rights & Oblig.

19. Relation of Transaction and Balance Objectives • Objectives are complementary (both types of tests help assure that objectives are met) • Quantities are inversely related • Both types of tests are usually performed • As more transaction tests are performed, related balance tests can be decreased

20. Related Objectives • Timing vs. Cutoff • Examine date of recording transactions (timing) • Examine date of recording transactions before and after year-end (cutoff)

21. Related Objectives • Posting & Summarization and Detail tie-in • Foot journal and trace to posting in ledger. Trace individual transactions to posting in master file (posting & summarization) • Foot A/R trial balance and agree to general ledger (detail tie-in)

22. Audit Objective Examples • Net Realizable Value • No corresponding transaction objective (some transaction tests may address) • Concerned with declines in assets below recorded value (Ex. Inquire as to any obsolete inventory)

23. Assertion Trans. Obj. Balance Obj. Exist./Occur Occurrence Existence Completeness CompletenessCompleteness Accuracy Accuracy Valuation Classific. Classific. or Timing Cutoff Allocation Post. & Summ. Detail tie-in None NRV Rights & Obl. N/A Rights & Obl.

24. Sample Objectives • Examine documents supporting sample of purchase invoices in acquisition journal. • Examine documents supporting purchases recorded in repair & maintenance account. • Examine last five purchases in acquisitions journal for recording in proper period.

25. Prob. 6-30 a. Examine a copy of duplicate sales invoices to determine whether each has a shipping document attached. e. For a sample of shipping documents selected from shipping records, trace each shipping document to a transaction recorded in the sales journal.

26. Prob. 6-30 b. Add all customer balances in the accounts receivable trial balance and agree the amount to the general ledger. c. For a sample of sales transactions selected from the sales journal, verify that the amount of the transaction has been recorded in the correct customer account in the accounts receivable subledger

27. Prob. 6-30 f. Discuss with credit department personnel the likelihood of collection of all accounts as of December 31, 2009 with a balance greater than $100,000 and greater than 90 days old as of year end. g. Examine sales invoices for the last five sales transactions recorded in the sales journal in 2009 and examine shipping documents to determine they are recorded in the correct period.