Audit Objective
Primary objective of the audit is to
express an opinion on the financial
statements
– Other objectives are secondary
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)
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
The Best Auditors
Come From This State
Sources of material misstatements in
financial statements:
Errors - Unintentional misstatement
of F/S
Fraud - Intentional misstatement
Fraud
• Fraudulent financial reporting
• Misappropriation of assets
• Illegal acts
– Direct effect
– Indirect effect
What are some management incentives to
misstate income?
Campbell Soup Case
Talking points
 Ownership control
 Objectives of fraud?
 How accomplished?
 Why were auditors not
found guilty?
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?
Prevention/Detection of Frauds
90
80
70
60
50
40
30
20
10
0
IC
Int. Aud
Empl.
Accident Ext. Aud
KPMG 2003
The Fraud Triangle
Incentives/Pressures
Opportunities
Attitudes/Rationalization
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
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?
1.
2.
3.
4.
Errors
Limited
Reasonable
Limited
Reasonable
Fraud
Negative
Reasonable
Limited
Limited
Direct-effect
Illegal Acts
Limited
Reasonable
Reasonable
Limited
Overview of Three Classes of Assertions
Class
Of Trans
Account
Balances
Presentation &
Disclosure
Occurrence
Existence
Occurrence/Rights
Completeness
Completeness
Completeness
Accuracy
Valuation/
Allocation
Accuracy/
Valuation
Classification
Classification/
Understandability
Cutoff
Rights/Obligations
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
An auditor would most likely analyze inventory
turnover rates to obtain evidence concerning
management’s assertions about:
1.
2.
3.
4.
Existence or occurrence
Rights and obligations
Valuation or allocation
Presentation and disclosure
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
Assertion
Trans. Objective
Occurrence
Occurrence
Completeness
Completeness
Valuation or
Allocation
Accuracy
Classification
Timing
Posting & Summ.
Rights & Oblig.
N/A
Assertion
Existence
Balance Objective
Existence
Completeness
Completeness
Valuation or
Allocation
Accuracy
Classification
Cutoff
Detail tie-in
Realizable Value
Rights & Oblig.
Rights & Oblig.
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
Related Objectives
• Timing vs. Cutoff
– Examine date of recording transactions
(timing)
– Examine date of recording transactions
before and after year-end (cutoff)
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)
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)
Assertion
Trans. Obj.
Balance Obj.
Exist./Occur
Occurrence
Existence
Completeness Completeness
Completeness
Accuracy
Valuation
Classific.
or
Timing
Allocation
Post. & Summ.
None
Rights & Obl. N/A
Accuracy
Classific.
Cutoff
Detail tie-in
NRV
Rights & Obl.
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.
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.
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
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.