Chapter 5 Audit Responsibilities and Objectives 5 1
Chapter 5: Audit Responsibilities and Objectives 5 -1 Copyright © 2007 Pearson Education Canada
Chapter 5 Objectives w Consider the objective of conducting an audit of financial statements w Explain the difference between management and auditor responsibilities w What is the nature and purpose of the cycle approach? 2 Copyright © 2007 Pearson Education Canada
Chapter 5 Objectives (continued) w Describe management assertions w Relate management assertions to general transaction-related and balance-related audit objectives w Discuss the audit process and its four phases 3 Copyright © 2007 Pearson Education Canada
Objective of an Audit of Financial Statements w Expression of an opinion w Are financial statements fairly presented? w Are financial statements in conformity with GAAP? w The audit is conducted by an independent auditor 4 Copyright © 2007 Pearson Education Canada
Management Responsibilities with Respect to financial statements w Adoption of sound accounting policies w Maintenance of adequate internal controls w Providing fair representations in the financial statements 5 Copyright © 2007 Pearson Education Canada
Hillsburg Hardware Illustrates Management Responsibilities w Hillsburg Hardware Limited illustrates management responsibilities: – P. 144 Management’s Accountability report – P. 149 Management’s Discussion and Analysis – P. 143 report on internal control is optional in Canada 6 Copyright © 2007 Pearson Education Canada
Auditor Responsibilities with Respect to Financial Statements w Expression of an opinion w Reasonable assurance that material misstatements are absent: – Includes errors, fraud and other irregularities w Plan and perform the audit in accordance with GAAS 7 Copyright © 2007 Pearson Education Canada
Types of Misstatements: Some are Difficult to Detect! w Error: unintentional misstatement w Fraud and other irregularities: intentional – Theft of assets, often employee fraud – Fraudulent financial reporting, often management fraud – Computer fraud – Illegal acts (direct-effect or indirect-effect) 8 Copyright © 2007 Pearson Education Canada
Provide some examples w Can you think of any recent financial fiascos talked about in the newspaper? w What type of errors were presented? w Was fraud involved? 9 Copyright © 2007 Pearson Education Canada
The Cycle Approach w A convenient way to separate transactions for study and assessment during the audit w Related types (or classes) of transactions are part of the same cycle 10 Copyright © 2007 Pearson Education Canada
Cycles Used in This Text w w Sales and collection Acquisition and payment Payroll and personnel Inventory and warehousing w Capital acquisition and repayment 11 Copyright © 2007 Pearson Education Canada
What are Management Assertions? w Implied or expressed representations by management about classes of transactions w Are directly related to GAAP w Part of criteria used by management to record and disclose information in the F/S 12 Copyright © 2007 Pearson Education Canada
Management’s Assertions w w w Existence Occurrence Completeness Valuation (realizable value) Accuracy, measurement or allocation w Ownership; rights and obligations w Presentation and disclosure 13 Copyright © 2007 Pearson Education Canada
Management Assertions Relate to Audit Objectives w Financial statements and financial statement cycles are used to develop management assertions about accounts w Each assertion directly relates to an audit objective (either general or specific) 14 Copyright © 2007 Pearson Education Canada
Developing General and Specific Audit Objectives w Each management objective is related to either a GENERAL transaction-related audit objective (for transactions) or a GENERAL balance-related audit objective (for general ledger ending balances) w When applied to a specific transaction or account, it becomes a SPECIFIC audit objective 15 Copyright © 2007 Pearson Education Canada
Management Assertion: Existence Do assets, obligations (liabilities) and equities exist? Are they REAL? w General Balance-Related Audit Objective: Existence w Specific Balance-Related Audit Objective for Inventory: All recorded inventories exist at the balance sheet date 16 Copyright © 2007 Pearson Education Canada
Management Assertion: Occurrence Did included transactions actually happen? Are they REAL? w General Transaction-Related Audit Objective: Occurrence w Specific Transaction-Related Audit Objective for Sales: Recorded sales are for shipments made to nonfictitious customers 17 Copyright © 2007 Pearson Education Canada
Management Assertion: Completeness All transactions and amounts that happened are included? Was anything MISSED or FORGOTTEN? w General Transaction-Related Audit Objective: Completeness w Specific Transaction-Related Audit Objective for Sales: Existing sales transactions are recorded w General Balance-Related Audit Objective: Existence w Specific Balance-Related Audit Objective for Inventory: All existing inventory has been counted and included in inventory 18 Copyright © 2007 Pearson Education Canada
Management Assertion: Valuation Is the asset at lower of cost or net realizable value? Is the liability at cost? w General Balance-Related Audit Objective: Valuation w Specific Balance-Related Audit Objective for Inventory: Inventories have been written down where net realizable value is less than book value 19 Copyright © 2007 Pearson Education Canada
Management Assertion: Accuracy (Measurement, Part 1) Were transactions and amounts recorded and processed properly? w General Transaction-Related Audit Objective: Accuracy w Specific Transaction-Related Audit Objective for Sales: Recorded sales are for the amount of goods shipped and are correctly billed and recorded w General Balance-Related Audit Objective: Accuracy w Specific Balance-Related Audit Objective for Inventory: Inventory quantities agree with items physically on hand (See also Table 5 -2, p. 125) 20 Copyright © 2007 Pearson Education Canada
Management Assertion: Classification (Measurement, Part 2) Were transactions and amounts recorded in the correct account? w General Transaction-Related Audit Objective: Classification w Specific Transaction-Related Audit Objective for Sales: Sales transactions are classified in the correct account w General Balance-Related Audit Objective: Classification w Specific Balance-Related Audit Objective for Inventory: Inventory items are properly classified as raw materials, work in process, or finished goods 21 Copyright © 2007 Pearson Education Canada
Management Assertion: Allocation (Measurement, Part 3) Were transactions and amounts recorded on the right dates in the correct period? w General Transaction-Related Audit Objective: Timing w Specific Transaction-Related Audit Objective for Sales: Sales are recorded on the correct dates w General Balance-Related Audit Objective: Cutoff w Specific Balance-Related Audit Objective for Inventory: Purchases at year end are recorded in the correct period (See also Table 5 -2, p. 125) 22 Copyright © 2007 Pearson Education Canada
Management Assertion: Measurement (Measurement, Part 4) Were transactions and amounts updated and aggregated to the correct account? w General Transaction-Related Audit Objective: Posting and Summarization w Specific Transaction-Related Audit Objective for Sales: Sales transactions are updated correctly to the customer master file, and totals posted to the G. L. account correctly. w General Balance-Related Audit Objective: Detail tie-in w Specific Balance-Related Audit Objective for Inventory: Total of inventory items agrees with G. L. 23 Copyright © 2007 Pearson Education Canada
Management Assertion: Rights and Obligations Rights: Do the assets on hand belong to the company? Obligations: Were the obligations incurred by the company (not by someone else)? w General Balance-Related Audit Objective: Rights and obligations w Specific Balance-Related Audit Objective for Inventory: The company has title to all inventory items listed. Inventories are not pledged as collateral. 24 Copyright © 2007 Pearson Education Canada
Management Assertion: Presentation and Disclosure Do the statements include all relevant information in a way that financial statement users can understand? w General Balance-Related Audit Objective: Presentation and Disclosure w Specific Balance-Related Audit Objective for Inventory: Major categories of inventories and their bases of valuation are disclosed. (See also Table 5 -2, p. 125) 25 Copyright © 2007 Pearson Education Canada
Practice problem 5 -20 (p. 133) w Practice matching the specific transactionrelated audit objective to the management assertion and to the general transactionrelated audit objective 26 Copyright © 2007 Pearson Education Canada
Practice problem 5 -22 (p. 134) w This problem provides a series of audit procedures w What objectives are these associated with? w It is important to understand these objectives, as you may be asked to provide audit procedures for a particular objective 27 Copyright © 2007 Pearson Education Canada
The Audit Process w Prior to accepting or continuing the audit, assess independence w Conduct four phases of an audit w In planning phase, prepare client risk profile and assess corporate governance 28 Copyright © 2007 Pearson Education Canada
Four Phases of an Audit w Phase I - Assess risk and plan the audit w Phase II - Perform tests of controls w Phase III - Perform analytical procedures and test of details of balances w Phase IV - Complete the audit and issue an auditor’s report 29 Copyright © 2007 Pearson Education Canada
Audit Phase I: Risk Assessment and Audit Planning w In the context of risks, balance the quantity and quality of evidence to be collected against costs of collection w Obtain knowledge of business, industry, business environment. Prepare client risk profile. w Understand internal control and assess control risk (governance, general controls, cycle controls) 30 Copyright © 2007 Pearson Education Canada
Practice problem 5 -23 (p. 134) w To understand risks, it is important to understand ‘what could go wrong’ w Here, you are asked to think like a devious client – how could you overstate net income? 31 Copyright © 2007 Pearson Education Canada
Audit Phase II: Perform Tests of Controls w Where the auditor plans to rely upon high quality internal controls, these controls may need to be tested (certain controls only need to be tested every three years, S 5143. 41) w Tests are normally linked to audit objectives (also called audit assertions) 32 Copyright © 2007 Pearson Education Canada
Audit Phase III: Perform Analytical Procedures and Tests of Details of Balances w Analytical procedures are both a planning tool and an actual audit test w Tests of details of balances are specific audit procedures designed to test for monetary misstatements 33 Copyright © 2007 Pearson Education Canada
Audit Phase IV: Complete and Issue the Auditor’s Report w Information collected during the audit needs to be combined and assessed to reach an overall conclusion with respect to the financial statements – are they fairly stated? w This assessment requires experience and professional judgment 34 Copyright © 2007 Pearson Education Canada
Practice problem 5 -24 (p. 134) w How do we pull this together? w Identify problems that could affect the audit engagement of ABC Electronics Ltd. , and provide some suggestions on how to deal with them. 35 Copyright © 2007 Pearson Education Canada
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