Audit Responsibilities

and Objectives
 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.
Steps to Develop Audit Objectives
• 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.
 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.
 Management’s Responsibilities
• The Sarbanes-Oxley Act provides for criminal penalties
for anyone who knowingly falsely certifies the statements.
 auditor’s responsibility
• The auditor is responsible of planning and performing the
audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement.

• The auditor is able to obtain reasonable BUT not absolute

assurance that material misstatements are detected.

• The auditor has no responsibility to plan and perform the

audit to obtain reasonable assurance that misstatements
(caused by errors or fraud) that are not material to the
financial statements are detected.
 Material versus immaterial
misstatements
• Misstatements are considered material if the combined
uncorrected errors and fraud in the financial statements
would likely have changed or influenced the decision of
reasonable person.
• It would be extremely costly (and impossible) for auditors
to have responsibility for finding all immaterial errors and
fraud.
• Auditors are responsible for obtaining reasonable
assurance.
 Reasonable assurance
• Assurance is a measure of the level of certainty that the
auditor has obtained at the completion of the audit.
• Reasonable assurance is a high, but not absolute, level of
assurance that the financial statements are free of
material misstatements.
• The auditor is responsible for reasonable assurance for
the following reasons :
1.Testing samples.
2.Estimations.
3.Fraud is extremely difficult to detect.
 Errors versus fraud
• Errors: are unintentional misstatements.
• Fraud: are intentional misstatements.
1. Misappropriation of Assets (Employee Fraud).
Harms stockholders and creditors because assets are no
longer available.
2. Fraudulent Financial Reporting.(management Fraud).
Harms users by providing them incorrect financial
statement information for their decision making.
 Professional skepticism
• The audit must be planned and performed with an attitude
of professional skepticism.
• Auditor should not assume that management is dishonest,
BUT the possibility of dishonesty must be considered.
 Auditor’s Responsibilities for
Discovering Illegal Acts

• Illegal acts : violation of laws or government regulations

other than fraud.
1.Violation of tax laws.
2.Violation of environmental protection laws.
 Direct-effect illegal acts

• Have a direct financial effect on specific account balances

in the financial statements.
• EX: violation of tax laws affects income tax expenses and
income tax payable.
 Indirect-effect illegal acts
• Affect financial statements only indirectly.
• EX: violation of environmental protection laws, financial
statements are only affected if there is a fine or sanctions.
 Actions when the auditor knows of an
illegal act
1. Consider the effect on the financial statements,
including the adequacy of disclosures.
2. Effect on the relationship with management (if
management knew of the illegal act).
3. Communicate with audit committee to make sure they
know of the illegal act.
4. If client refuses of fails to take appropriate action, the
auditor may withdrew from the engagement.
5. If client is publicly held the auditor must report to the
SEC.
 Financial Statements Cycles
• Audits are performed by dividing the financial statements
into smaller segments or components.
• Keeping closely related types (or classes) of transactions
and account balances in the same segment.
• After the audit of each segment is completed, including
interrelationships with other segments, the results are
combined. A conclusion can be reached about the
financial statements taken as a whole.
 Setting audit objectives
1. Transaction related audit objectives.
2. Balance related audit objectives.
3. Presentation and Disclosure audit objectives.
Managements Assertions
• Are implied or expressed representations by management
about classes of transactions and the related accounts
and disclosures in the financial statements.
• Assertions are classified into three categories :
1.Assertions about classes of transactions and events
for the period under audit.
2.Assertions about account balances at period end.
3.Assertions about presentation and disclosure.
 Assertions about classes of
transactions and events
• Occurrence: transactions included in the financial
statements Actually occurred during the accounting
period.Ex: recorded sales.
• Is concerned with the possibility of including transactions
that should not been included
• Relates to account overstatement.
• Completeness: all transactions that should be included in
the financial statements are in fact included. Ex: all sales
are recorded.
• Opposite from occurrence.
• Is concerned with the possibility of omitting transactions.
• Relates to account understatement.
• Accuracy: whether transactions have been recorded at
correct amounts.
• Classification: whether transactions are recorded in the
appropriate accounts.
• Cutoff: whether transactions are recorded in the proper
accounting period.
Assertions about account balances
• Existence: whether assets, liabilities, and equity included
in the balance sheet actually existed on the balance sheet
date.
• Is concerned with the possibility of including amounts that
should not been included.
• Relates to account overstatement.
• Completeness: whether all accounts and amounts that
should be presented in the financial statements are in fact
included.
• Is concerned with the possibility of omitting items.
• Relates to account understatement.
• Valuation and Allocation: whether assets, liabilities and
owners interests have been included in the financial
statements at appropriate amounts, including any
valuation adjustments to reflect assets amounts at net
realizable value.
• Rights and obligations: whether assets are the rights of
the entity and whether liabilities are the obligations of the
entity.
 Assertions about presentation and disclosure

• Occurrence and rights and obligations: whether

disclosed events have occurred and are the rights and
obligations of the entity.
• Completeness: whether all required disclosures have
been included in the financial statements. EX: all material
related party transactions have been disclosed.
• Accuracy and valuation: whether financial information is
disclosed fairly and at appropriate amounts.
• Classification and Understandability: whether amounts
are appropriately classified in the financial statements and
in the footnotes. EX: classification of inventory.
 Management Assertions for
Each Category of Assertions
Assertions About Classes Assertions About Assertions About
of Transactions and Events Account Balances Presentation and Disclosure
Occurrence Existence Occurrence and rights
and obligations
Completeness Completeness Completeness
Accuracy Valuation and Accuracy and
allocation valuation
Classification Classification and
understandability
Cutoff
Rights and
obligations
General Transactions-related Audit Objectives

• Occurrence: Recorded transactions exist.

• Deals with potential overstatement.
• Completeness: Existing transactions are recorded.
• Deals with potential Understatement.
• Accuracy: A-Recorded transactions are stated at the
correct amounts.
• B-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.
 Transaction Related Audit Objectives

Management Assertions General Transaction- Specific Sales Transaction-

About Classes of related Audit related Audit Objectives
Transactions and Events 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
 Transaction Related Audit Objectives

Management Assertions General Transaction- Specific Sales Transaction-

About Classes of related Audit related Audit Objectives
Transactions and Events Objectives

Accuracy Posting and Sales transactions are

summarization 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.
 Balance-related Audit Objectives
• Existence: amounts included Exist. Inclusion of an A/R
from a customer in the trial balance when there is no
receivable violates this objective.
• Counterpart to the management assertion of existence.
• Deals with overstatement.
• Completeness: Existing amounts are included. Failure to
include an A/R from a customer in the trial balance.
• Counterpart to the management assertion of
completeness.
• Deals with understatement.
• Accuracy:
• A) Amounts included are stated at the correct amounts:
the amounts should be included at the correct amount.
• B) Classification: Amounts are properly classified. EX:
classifying assets .
• C) Cutoff: Transactions are recorded in the proper period.
• D) Detail tie-in: Account balances agree with master file
amounts, and with the general ledger.
• Realizable value: Assets are included at estimated
realizable value.(reduce historical cost or fair market value
is required).
• Rights and obligations: Assets must be owned and
liabilities must belong to the entity.
 Balance Related Audit Objectives
(Applied to Inventory)

Management Assertions General Balance- Specific Balance-related Audit

About Account Balances related Audit Objectives Applied to Inventory
Objectives
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
 Balance Related Audit Objectives
(Applied to Inventory)

Management Assertions General Balance- Specific Balance-related Audit

About Account Balances related Audit Objectives Applied to Inventory
Objectives
Valuation and Accuracy • Inventory quantities on the
allocation 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
 Balance Related Audit Objectives
(Applied to Inventory)

Management Assertions General Balance- Specific Balance-related Audit

About Account Balances related Audit Objectives Applied to Inventory
Objectives
Valuation and Classification Inventory items are properly
allocation classified as to raw
materials, work in process,
and finished goods
Cutoff Purchase cutoff at year end
is proper
Sales cutoff at year end is
proper
 Balance Related Audit Objectives
(Applied to Inventory)

Management Assertions General Balance- Specific Balance-related Audit

About Account Balances related Audit Objectives Applied to Inventory
Objectives
Valuation and Detail tie-in Total of inventory items
allocation agrees with general ledger
Realizable Inventories have been written
value down where net realizable
value is impaired
Rights and obligations Rights and The company has title to all
obligations inventory items listed
Inventories are not pledged
as collateral
Presentation and Disclosure Audit objectives
(Applied to Notes Payable)

Management General Specific Presentation and

Assertions About Presentation- Disclosure-related Audit Objectives
Presentation and and Disclosure- Applied to Notes Payable
Disclosure related Audit
Objectives
Occurrence Occurrence Notes payable as described in the
and rights and and rights and footnotes exist and are
obligations obligations obligations of the company
Completeness Completeness All required disclosures related
to notes payable are included in
the financial statement footnotes
Presentation and Disclosure Audit objectives
(Applied to Notes Payable)

Management General Specific Presentation and

Assertions About Presentation- Disclosure-related Audit Objectives
Presentation and and Disclosure- Applied to Notes Payable
Disclosure related Audit
Objectives
Valuation and Valuation and Footnote disclosures related to
allocation allocation notes payable are accurate.
Classification Classification Notes payable are appropriately
and and classified as to short-term and
understandability understandability long-term obligations and
related financial statement
disclosures are understandable
 How Audit Objectives Are Met
• The auditor must obtain sufficient appropriate audit
evidence to support all management assertions in the
financial statements.
• The auditor must decide the appropriate audit objectives
and evidence to accumulate to meet those objectives on
every audit.

• To do this auditors follow an audit process.

• Audit process: methodology for organizing an audit to

ensure that the evidence gathered is both sufficient and
appropriate and that all required audit objectives are both
specified and met.
 Four Phases of a Financial Statement
Audit
Perform analytical
Plan and design procedures and
Phase I an audit approach Phase III tests of details
of balances

Perform tests of
Complete the
controls and
Phase II substantive tests Phase IV audit and issue
an audit report
of transactions
Phase I
Plan and design an audit approach
• There are two considerations affecting the approach the
auditor selects to accumulate evidence:
1.Sufficient appropriate evidence must be accumulated.
2.The cost of accumulating the evidence should be
minimized.
• Planning and designing au audit approach can be broken
down into several parts :
1.Obtain an understanding of the entity and its
Environment.
2.Understand internal control and assess control risk.
3.Assess Risk of material misstatement.
Phase II
Perform tests of controls and substantive
tests of transactions
• By performing TESTS of CONTROLS the auditor can
justify reducing planned assessed control risk when
controls are believed to be effective.
• SUBSTANTIVE Test of Transactions : evaluate the clients
recording of transactions.
Phase III
Perform analytical procedures and
tests of details of balances
• Analytical procedures : use comparisons and
relationships. EX : examine the sales journal and compare
results to prior periods.
• Tests of Details : specific procedures intended to test for
monetary misstatements in the balances in the financial
statements. EX: direct written communication with client’s
customers to decide on the accuracy of A/R.
Phase IV
Complete the audit and issue an audit
report
• Reach and overall conclusion as to whether the financial
statements are free of material misstatements.