arens aud16 inppt06-M2 (1)

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AUDIT
RESPONSIBILITIES
AND OBJECTIVES
CHAPTER 6
Copyright © 2017 Pearson Education, Ltd.
6-1
CHAPTER 1 LEARNING OBJECTIVES
6-1 Explain the objective of conducting an audit of financial statements
and an audit of internal controls.
6-2 Distinguish management’s responsibility for the financial statements
from the auditor’s responsibility for verifying those statements.
6-3 Explain the auditor’s responsibility for discovering material
misstatements due to fraud or error.
6-4 Describe the need to maintain professional skepticism when
conducting an audit.
.
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6-2
CHAPTER 1 LEARNING OBJECTIVES (CONT.)
6-5 Describe the key elements of an effective professional judgment
process.
6-6 Identify the benefits of a cycle approach to segmenting the audit.
6-7 Describe why the auditor obtains assurance by auditing transactions
and ending balances, including presentation and disclosure.
6-8 Distinguish among the management assertions about financial
information.
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6-3
CHAPTER 1 LEARNING OBJECTIVES (CONT.)
6-9 Link transaction-related audit objectives to management assertions
for classes of transactions.
6-10 Link balance-related and presentation and disclosure-related audit
objectives to management assertions.
6-11 Explain the relationship between audit objectives and the
accumulation of audit evidence.
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6-4
OBJECTIVE 6-1
Explain the objective of conducting an
audit of financial statements and an
audit of internal controls.
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6-5
OBJECTIVE TO CONDUCTING AN AUDIT OF
FINANCIAL STATEMENTS
The preface to the clarified AICPA auditing standards:
The primary focus is on issuing an opinion on the financial statements.
The steps to develop audit objectives are listed in Figure 6-1.
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MCQS
• 1) The objective of an audit of the financial statements is an expression of an opinion on
• A) the fairness of the financial statements in all material respects.
• B) the accuracy of the financial statements.
• C) the accuracy of the annual report.
• D) the accuracy of the balance sheet and income statement.
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MCQ
• Auditors accumulate evidence to
• A) defend themselves in the event of a lawsuit.
• B) determine if the financial statements are correct.
• C) satisfy the requirements of the Securities Acts of 1933 and 1934.
• D) reach a conclusion about the fairness of the financial statements.
• Answer: D
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MCQ
• Which of the following is not one of the steps used to develop audit objectives?
• A) know the proper type of audit opinion to issue
• B) divide the financial statements into cycles
• C) know the management assertions about the financial statements
• D) know the specific audit objectives for classes of transactions
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10
OBJECTIVE 6-2
Distinguish management’s responsibility
for the financial statements from the
auditor’s responsibility for verifying
those statements.
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6-11
MANAGEMENT’S RESPONSIBILITIES
Financial statements and internal controls.
Sarbanes-Oxley increases management’s
responsibility for the financial statements.
CEO and CFO must certify quarterly and annual
financial statements submitted to the SEC.
Many public companies include a statement regarding management responsibility
in relation to the CPA firm. An example of such a statement is included in Figure 6-2.
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6-13
MCQ
• The responsibility for the preparation of the financial statements and the
accompanying footnotes belongs to
• A) the auditor.
• B) management.
• C) both management and the auditor equally.
• D) management for the statements and the auditor for the notes.
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OBJECTIVE 6-3
Explain the auditor’s responsibility
for discovering material misstatements
due to fraud or error.
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6-15
AUDITOR’S RESPONSIBILITIES
AICPA auditing standards state:
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AUDITOR’S RESPONSIBILITIES (CONT.)
Errors versus Fraud:
An error is an unintentional misstatement of the financial statements, whereas
fraud is intentional.
For fraud, there is a distinction between misappropriation of assets, usually
committed by employees, and fraudulent financial reporting, usually committed
by management.
Auditor’s Responsibilities for Detecting Material Errors:
Auditors spend a great portion of their time planning and performing audits to
detect unintentional errors made by management and employees.
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AUDITOR’S RESPONSIBILITIES (CONT.)
Auditor’s Responsibilities for Detecting Material Fraud:
Auditing standards make no distinction between the auditor’s responsibilities for
detecting errors versus fraud.
However, the standards do recognize that fraud is more difficult to detect because
those who are committing the fraud attempt to conceal the fraud.
Fraudulent Financial Reporting versus Misappropriation of Assets: Both are
harmful to financial statement users. Fraudulent financial statements present
users with incorrect financial information that is used for decision making.
Misappropriation of assets is harmful to creditors, stockholders, and others
because the assets have been taken from their rightful owners, the company.
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6-18
AUDITOR’S RESPONSIBILITIES FOR DISCOVERING
ILLEGAL ACTS
Type
Responsibility
Direct-Effect
Same as for
errors and
fraud
Indirect-Effect
No Assurance
AUDITOR’S RESPONSIBILITIES (CONT.)
Audit Procedures When Noncompliance Is Identified or Suspected: The auditor
should obtain an understanding of the situation and discuss the matter with
management at a level above those involved.
Auditors should obtain sufficient evidence regarding material amounts that are
directly affected by laws and regulations.
Laws such as those relating to taxes and pensions usually have a direct effect on
the amounts or disclosures in the financial statements, and therefore require the
auditor’s attention.
Reporting Identified or Suspected Noncompliance: Unless the matter is
inconsequential, the auditor should communicate with those charged with
governance of matters of noncompliance.
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MCQ
• ) The auditor's best defense when material misstatements are not uncovered is to
have conducted the audit
• A) in accordance with International Standards On Auditing.
• B) as effectively as reasonably possible.
• C) in a timely manner.
• D) only after an adequate investigation of the management team.
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21
MCQ
• Which of the following is not one of the reasons that auditors provide only
reasonable assurance on the financial statements?
• A) The auditor commonly examines a sample, rather than the entire population of
transactions.
• B) Accounting presentations contain complex estimates which involve uncertainty.
• C) Fraudulently prepared financial statements are often difficult to detect.
• D) Auditors believe that reasonable assurance is sufficient in the vast majority of
cases.
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22
MCQ
• Which of the following statements is the most correct regarding errors and fraud?
• A) An error is unintentional, whereas fraud is intentional.
• B) Frauds occur more often than errors in financial statements.
• C) Errors are always fraud and frauds are always errors.
• D) Auditors have more responsibility for finding fraud than errors.
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23
MCQ
• ) When an auditor believes that an illegal act may have occurred, the auditor should
first
• A) obtain an understanding of the nature and circumstances of the act.
• B) consult with legal counsel or others knowledgeable about the illegal act.
• C) discuss the matter with the audit committee.
• D) withdraw from the engagement.
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MCQ
• Fraudulent financial reporting is most likely to be committed by whom?
• A) line employees of the company
• B) outside members of the company's board of directors
• C) company management
• D) the company's auditors.
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MCQ
• The concept of reasonable assurance indicates that the auditor is
• A) not a guarantor of the correctness of the financial statements.
• B) not responsible for the fairness of the financial statements.
• C) responsible only for issuing an opinion on the financial statements.
• D) responsible for finding all misstatements.
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MCQ
• Which of the following is the auditor least likely to do when aware of an illegal act?
• A) discuss the matter with the client's legal counsel
• B) obtain evidence about the potential effect of the illegal act on the financial
statements
• C) contact the local law enforcement officials regarding potential criminal
wrongdoing
• D) consider the impact of the illegal act on the relationship with the company's
management
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MCQ
• An auditor discovers that the company's bookkeeper unintentionally made an
mistake in calculating the amount of the quarterly sales. This is an example of
• A) employee fraud.
• B) an error.
• C) misappropriation of assets.
• D) a defalcation.
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MCQ
• An auditor has a duty to
• A) provide reasonable assurance that material misstatements will be detected.
• B) be a guarantor of the fairness in the statements.
• C) be equally responsible with management for the preparation of the financial
statements.
• D) be an insurer of the fairness in the statements.
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MCQ
• When dealing with laws and regulations that do not have a direct effect on the
financial statements, the auditor
• A) should inquire of management about whether the entity is in compliance with
such laws and regulations.
• B) has no responsibility to determine if any violations of these laws has occurred.
• C) must report all violations, including inconsequential violations, to the audit
committee.
• D) should perform the same procedures as for violations having a direct effect on the
financial statements.
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MCQ
• Which of the following statements is usually true?
• A) Materiality is easy to quantify.
• B) Fraudulent financial statements are often easy for the auditor to detect, especially
when there is collusion among management.
• C) Reasonable assurance is a low level of assurance that the financial statements are
free from material misstatement.
• D) An item is considered material if it would likely have changed or influenced the
decisions of a reasonable person using the statements.
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MCQ
• ) In comparing management fraud with employee fraud, the auditor's risk of failing
to discover the fraud is
• A) greater for management fraud because managers are inherently more deceptive
than employees.
• B) greater for management fraud because of management's ability to override
existing internal controls.
• C) greater for employee fraud because of the higher crime rate among blue collar
workers.
• D) greater for employee fraud because of the larger number of employees in the
organization.
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MCQ
• Misappropriation of assets
• A) is generally committed by company management.
• B) harms the users of the financial statements by providing them incorrect financial
data for their decision making.
• C) causes harm to stockholders because the assets are no longer available to their
rightful owners.
• D) causes the financial statements to be misstated since the misappropriation
usually involves material amounts.
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MCQ
• ) When comparing the auditor's responsibility for detecting employee fraud and for
detecting errors, the profession has placed the responsibility
• A) more on discovering errors than employee fraud.
• B) more on discovering employee fraud than errors.
• C) equally on discovering errors and employee fraud.
• D) on the senior auditor for detecting errors and on the manager for detecting
employee fraud.
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MCQ
• ) If there is collusion among management, the chance a normal audit would uncover
such acts is
• A) very low.
• B) very high.
• C) zero.
• D) none of the above.
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MCQ
• When the auditor becomes aware of or suspects noncompliance with laws and
regulations
• A) the auditor should evaluate the effects of the noncompliance on other aspects of
the audit.
• B) the auditor should discuss the matter with management at a level above those
suspected of the noncompliance.
• C) the auditor should obtain additional information to evaluate the possible effects
on the financial statements.
• D) all of the above
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MCQ
• ) When an auditor knows that an illegal act has occurred, she must
• A) report it to the proper governmental authorities.
• B) consider the effects on the financial statements, including the adequacy of
disclosure.
• C) withdraw from the engagement.
• D) issue an adverse opinion.
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OBJECTIVE 6-4
Describe the need to maintain professional
skepticism when conducting an audit.
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PROFESSIONAL SKEPTICISM
Aspects of Professional Skepticism: Two primary components: A questioning
mindset and a critical assessment of audit evidence.
Elements of Professional Skepticism:
1. Questioning mindset—“trust but verify”—a disposition to inquiry with some
sense of doubt.
2. Suspension of judgment—withholding judgment until appropriate evidence is
obtained.
3. Search for knowledge—a desire to investigate beyond the obvious, with a
desire to corroborate.
4. Interpersonal understanding—recognition that people’s motivations and
perceptions can lead them to provide biased or misleading information.
5. Autonomy—the self-direction, moral independence, and conviction to decide
for oneself, rather than accepting the claims of others.
6. Self-esteem—the self-confidence to resist persuasion and to challenge
assumptions or conclusions.
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6-18
MCQ
• An audit must be performed with an attitude of professional skepticism.
Professional skepticism consists of two primary components: a questioning mind
and
• A) the assumption that upper-level management is dishonest.
• B) a critical assessment of the audit evidence.
• C) the assumption that all employees are motivated by greed.
• D) verification of all critical information by independent third parties.
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MCQ
• ) One of the characteristics of professional skepticism is ________, which is the
conviction to decide for oneself, rather than accepting the claims of others.
• A) interpersonal understanding
• B) autonomy
• C) suspension of judgment
• D) self-esteem
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MCQ
A questioning mindset
A) means the auditor must prove every statement that management makes to them.
B) means the auditor should approach the audit with a "do not trust anyone" mental
outlook.
C) assures that the auditor will only accept honest clients.
D) means the auditor should approach the audit with a "trust but verify" mental
outlook.
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MCQ
• One of the characteristics of professional skepticism is_______, which is a desire to
investigate beyond the obvious.
• A) self-esteem
• B) an interpersonal understanding
• C) a search for knowledge
• D) a questioning mindset
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MCQ
• ) ________ is the self-confidence to resist persuasion and to challenge assumptions or
conclusions.
• A) Self-esteem
• B) Interpersonal understanding
• C) Suspension of judgment
• D) Autonomy
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44
MCQ
• An auditor should recognize that the application of auditing procedures may
produce evidence indicating the possibility of errors of fraud and therefore should
• A) plan and perform the engagement with an attitude of professional skepticism.
• B) not rely on internal controls that are designed to prevent or detect errors or
fraud.
• C) design audit tests to detect unrecorded transactions.
• D) extend the work to audit the majority of the recorded transactions and records of
an entity.
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OBJECTIVE 6-5
Describe the key elements of an effective
professional judgment process.
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6-46
PROFESSIONAL JUDGMENT
Professional judgment is part of professional skepticism.
Elements of the Judgment Process:
• Identify and define the issue.
• Gather the facts and information and identify the relevant literature.
• Perform the analysis and identify potential alternatives.
• Make the decision.
• Review and complete the documentation and rationale for the
conclusion.
These five key elements are illustrated in Figure 6-3.
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PROFESSIONAL JUDGMENT (CONT.)
Some potential judgment tendencies, traps, and biases to keep in mind:
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• ) The starting point to effective professional judgment begins with
• A) gathering the facts.
• B) identifying alternatives.
• C) identifying relevant literature.
• D) identifying and defining the issue.
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OBJECTIVE 6-6
Identify the benefits of a cycle approach
to segmenting the audit.
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6-51
FINANCIAL STATEMENT CYCLES
A common form of segmenting is called the cycle approach, which divides
classes of transactions and account balances that are closely related into
segments.
The cycles used in this text are listed below and detailed in Figure 6-4.
• Sales and collection cycle
• Acquisition and payment cycle
• Payroll and personnel cycle
• Inventory and warehousing cycle
• Capital acquisition and repayment cycle
A trial balance is illustrated in Figure 6-5, with accounts categorized by cycle.
Cycles applied to the trial balance are illustrated in Table 6-2.
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OBJECTIVE QUESTION
• Listed below are several accounts listed from a company's trial balance. Next to each
account put the letter corresponding to the transaction cycle used to audit the account.
• S = Sales and collection cycle
I = Inventory and warehousing cycle
• A = Acquisition and payment cycle
C = Capital acquisition and repayment cycle
• P = Payroll and personnel cycle
•
• 1. ________
commissions
Sales returns and allowances
5. ________
• 2. ________
Capital stock
6. ________
Cost of goods sold
• 3. ________
Buildings
7. ________
Trade accounts receivable
• 4. ________
Notes payable
8. ________
Rent
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Salaries and
56
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FINANCIAL STATEMENT CYCLES (CONT.)
Relationships among cycles are illustrated in Figure 6-6 below.
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OBJECTIVE 6-7
Describe why the auditor obtains assurance
by auditing transactions and ending balances,
including presentation and disclosure.
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SETTING AUDIT OBJECTIVES
The most efficient way to conduct audits is to obtain some
combination of assurance for each class of transactions and for
the ending balances in the related accounts.
Audit objectives for each class of transactions include:
• Transaction-related audit objectives
• Balance-related audit objectives
• Presentation and disclosure-related audit objectives.
Figure 6-7 presents an illustration of balances and transactions affecting the
balances for Accounts Receivable.
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6-30
MCQ
• Auditors have found that generally the most efficient and effective way to conduct
audits is to
• A) obtain complete assurance about the correctness of each class of transactions
affecting the account.
• B) obtain some combination of assurance for each class of transactions and for the
ending balance in the related accounts.
• C) obtain assurance about the ending balance of the account only.
• D) verify each entry that was made into an account.
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MCQ
• The term audit objective refers to all of the following except for
• A) transaction-related audit objectives.
• B) presentation and disclosure-related audit objectives.
• C) balance-related audit objectives.
• D) cycle-related audit objectives.
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64
MCQ
• Which of the following is not one of the AICPA categories of assertions?
• A) assertions about classes of transactions and events for the period under audit
• B) assertions about financial statements and correspondence to GAAP
• C) assertions about account balances at period end
• D) assertions about presentation and disclosure
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65
OBJECTIVE 6-8
Distinguish among the management
assertions about financial information.
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MANAGEMENT ASSERTIONS
Management assertions are implied or expressed representations by
management about classes of transactions and the related accounts
and disclosures in the financial statements.
Assertions by management are directly related to the financial
reporting framework (U.S. GAAP or IFRS) that forms the criteria that
management uses to record and disclose accounting information in
financial statements.
Management assertions lead to the audit objectives. Therefore,
auditors must have a thorough understanding of management
assertions to perform quality audits.
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MCQ
• Management assertions are
• A) directly related to the financial reporting framework used by the company,
usually U.S. GAAP or IFRS.
• B) stated in the footnotes to the financial statements.
• C) explicitly expressed representations about the financial statements.
• D) provided to the auditor in the assertions letter, but are not disclosed on the
financial statements.
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MANAGEMENT ASSERTIONS (CONT.)
The PCAOB standards describe five categories of management assertions:
• Existence or occurrence
• Completeness
• Valuation or allocation
• Rights and obligations
• Presentation and disclosure
AICPA and IFRS describe three categories of assertions:
• Assertions about classes of transactions and events
• Assertions about account balances
• Assertions about presentation and disclosure
Table 6-3 maps the PCAOB standards with the AICPA and IFRS standards.
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MCQ
• ) If a short-term note payable is included in the accounts payable balance on the
financial statement, there is a violation of the
• A) completeness assertion.
• B) existence assertion.
• C) cutoff assertion.
• D) classification assertion.
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71
MCQ
• International auditing standards and U.S. GAAP classify assertions into three
categories. Which of the following is not a category of assertions that management
makes about the accounting information in financial statements?
• A) assertions about classes of transactions for the period under audit
• B) assertions about account balances at period end
• C) assertions about the quality of source documents used to prepare the financial
statements
• D) assertions about presentation and disclosure
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OBJECTIVE 6-9
Link transaction-related audit objectives
to management assertions for
classes of transactions.
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TRANSACTION-RELATED AUDIT OBJECTIVES
General Transaction-Related Audit Objectives:
• Occurrence—Recorded transactions exist.
• Completeness—Existing transactions are recorded.
• Accuracy—Recorded transactions are stated at the correct amounts.
• Posting and Summarization—Recorded transactions are properly
included in the master files and are correctly summarized.
• Classification—Transactions included in the client’s journals are
properly classified.
• Timing—Transactions are recorded on the correct dates.
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TRANSACTION-RELATED AUDIT OBJECTIVES (CONT.)
Specific Transaction-Related Audit Objectives—The specific transactionrelated objectives are tailored to the specific class of transactions being
audited.
Relationship Among Management Assertions and Transaction-Related Audit
Objectives—For each management assertion, there are general transactionrelated audit objectives as well as specific transaction-related audit objectives.
Table 6-4 illustrates these relationships using sales transactions.
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MCQ
4) ________ deals with potential overstatement and ________ deals with
understatements (unrecorded transactions).
A) Occurrence; completeness
B) Completeness; occurrence
C) Accuracy; classification
D) Classification; accuracy.
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MCQS
• Management makes the following assertions about account balances:
• A) existence, completeness, classification and cutoff.
• B) existence, accuracy, classification and rights and obligations.
• C) existence, completeness, valuation and allocation, and rights and obligations.
• D) existence, completeness, rights and obligations, and cutoff.
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MCQS
• Management's disclosure of the amount of unfunded pension obligations and the
assumptions underlying these amounts is an example of the ________ assertion.
• A) completeness
• B) existence
• C) accuracy and valuation
• D) rights and obligations
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OBJECTIVE 6-10
Link balance-related and presentation and
disclosure-related audit objectives to
management assertions.
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BALANCE-RELATED AND PRESENTATION AND
DISCLOSURE-RELATED AUDIT OBJECTIVES
General Balance-Related Audit Objectives:
• Existence—Amounts included exist.
• Completeness—Existing amounts are included.
• Accuracy—Amounts included are stated at the correct amounts.
• Classification—Amounts included in the client’s listing are properly classified.
• Cutoff—Transactions near the balance sheet date are recorded in the proper
period.
• Detail Tie-In—Details in the account balance agree with related master file
amounts, foot to the total in the account balance, and agree with the total.
• Realizable Value—Assets are included at the amounts estimated to be realized.
• Rights and Obligations—Assets are owned or controlled by the entity, and
liabilities are obligations of the entity.
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BALANCE-RELATED AND PRESENTATION AND
DISCLOSURE-RELATED AUDIT OBJECTIVES (CONT.)
Specific Balance-Related Audit Objectives—The same as for transactionrelated audit objectives, each balance-related audit objective should be
tailored to the account balance being audited.
Relationship Among Management Assertions and Balance-Related Audit
Objectives—These relationships for Inventory are illustrated in Table 65.
Presentation and Disclosure-Related Audit Objectives—These
relationships for Notes Payable are illustrated in Table 6-6.
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MCQ
• 1) In testing for cutoff, the objective is to determine
• A) whether all of the current period's transactions are recorded.
• B) whether transactions are recorded in the correct accounting period.
• C) the proper cutoff between capitalizing and expensing expenditures.
• D) the proper cutoff between disclosing items in footnotes or in account balances.
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OBJECTIVE 6-11
Explain the relationship between audit objectives
and the accumulation of audit evidence.
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HOW AUDIT OBJECTIVES ARE MET
Figure 6-8 illustrates four phases of the audit.
Phase I: Plan and Design an Audit Approach.
The main objective of an audit is to accumulate enough evidence to
provide an opinion on the financial statements. Two overriding
considerations affect how an auditor approaches the audit:
1. Sufficient appropriate evidence must be accumulated to meet the
auditor’s professional responsibility.
2. The cost of accumulating the evidence should be minimized.
The audit plan should result in an effective audit at a reasonable cost.
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HOW AUDIT OBJECTIVES ARE MET (CONT.)
Phase I: Plan and Design and Audit Approach (cont.).
Risk assessment procedures include the following:
• Obtain an understanding of the entity and its environment.
• Understand internal control and assess control risk.
• Assess risk of material misstatement.
Phase II: Perform Tests of Controls and Substantive Tests of Transactions.
• Tests of controls allow the auditor to evaluate the effectiveness of
internal controls and determine whether the controls can be relied
upon to reduce planned control risks.
• Substantive tests of transactions allow the auditor to evaluate the
client’s recording of transactions.
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HOW AUDIT OBJECTIVES ARE MET (CONT.)
Phase III: Perform Substantive Analytical Procedures and Tests of Details
of Balances.
• Analytical procedures consist of evaluations of plausible relationships
among financial and nonfinancial data.
• Tests of details of balances are specific procedures intended to test for
monetary misstatements in the financial statements.
Phase IV: Complete the Audit and Issue and Audit Report.
• After all procedures have been completed, the auditor will reach an
overall conclusion as to whether the financial statements are fairly
presented.
• After the conclusion, the auditor must issue an audit report that will
accompany the client’s financial statements.
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