Chapter 6
©2010 Prentice Hall Business Publishing, Auditing 12/e,
13/e, Arens/Beasley/Elder
Arens/Elder/Beasley
6-1
In ALL of these steps, the auditor
will be attempting to
obtain sufficient appropriate
evidence in order to
achieve audit objectives
related to management’s
assertions
regarding their financial
transactions, balances and
disclosures.
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6-2
 Describe why the auditor obtains a
combination of assurance by auditing
classes of transactions and ending
balances in accounts, including
presentation and disclosure.
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6-3
Accounts Receivable (in thousands)
Beginning balance $ 17,521
Sales
$144,328
If we audit the B. Bal and
c/y transactions why audit
E. Bal?
Ending balance
$137,087 Cash receipts
$
Sales returns
1,242 and allowances
$
Charge-off of
3,323 uncollectible
accounts
$ 20,197
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6-4
 The account balances as of a point in time
 Transactions and events that occur during a
given accounting period of time
Inventory
Beginning Balance
Purchases
Cost of Goods Sold
Ending Balance
 The presentation in the financial statements of the
account balances and related footnote disclosures
 See example on next page
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6-5
 Inventories
 We compute inventory cost on a currently adjusted
standard basis (which approximates actual cost on
an average or first-in, first-out basis). Inventories at
year-ends were as follows:





(In Millions)
Raw materials
Work in process
Finished goods
Total inventories
2009
$ 437
1,469
1,029
$ 2,935
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
2008
$ 608
1,577
1,559
$ 3,744
6-6
 Distinguish among the three categories of
management assertions about financial
information.
 Transactions
 Balances
 Presentation and Disclosure
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6-7
 Who is responsible for the fair presentation of
the balances, transactions and disclosures?
 How does this group assert this responsibility?
 What is the auditor’s responsibility?
Here Mr. Auditor
are our financial
statements, I
assert that….
Management
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In our opinion,
the financial
statements…
present fairly….
External Auditor
6-8
Completeness T, B, P
Accuracy T, P
Valuation and allocation B, P
Existence B
Cutoff T
Rights & obligations B, P
Occurrence T, P
Classification T, P & Understandability P
T: Assertions about classes of transactions and
events for the period under audit
B: Assertions about account balances at period end
P: Assertions about presentation and disclosure
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6-9
Assertions About Classes
of Transactions and Events
Assertions About Assertions About
Account Balances Presentation and Disclosure
Rights and
obligations
Rights and obligations
Occurrence
Existence
Occurrence
Completeness
Completeness
Completeness
Accuracy
Valuation and
allocation
Accuracy and
valuation
Classification
Classification and
understandability
Cutoff
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6 - 10
Assertions About Classes
of Transactions and Events
Audit Objectives
Description
Occurrence
Occurrence
Recorded transactions
exist
Completeness
Completeness
Accuracy
Accuracy
Existing transactions are
recorded
Recorded transactions
are stated at the
CORRECT amounts
Recorded transactions are
properly included in the master
files and are correctly summarized
Transactions included in the
client’s journals are properly
classified
Posting and
Summarization
Classification
Classification
Cutoff
Timing
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Transactions are recorded
on the correct dates
6 - 11
Hillsburg Hardware Co.
(Applied to Sales Transactions)
Management Assertions
About Classes of
Transactions and Events
General Transactionrelated Audit
Objectives
Specific Sales Transactionrelated Audit 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
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6 - 12
Hillsburg Hardware Co.
(Applied to Sales Transactions)
Management Assertions
About Classes of
Transactions and Events
General Transactionrelated Audit
Objectives
Specific Sales Transactionrelated Audit Objectives
Accuracy
Posting and
summarization
Sales transactions are
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.
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6 - 13
Assertions About
Account Balances
Audit Objectives
Description
Rights and
obligations
Rights and
obligations
Client has rights to reported
Assets and is obligated to pay on
reported liabilities
Existence
Existence
Amounts included exist
Completeness
Completeness
Existing amounts
are included
Valuation and
allocation
Realizable
Value
Assets are included at the amounts
estimated to be realized
Accuracy
Amounts included are stated
at the correct amounts
Classification
Amounts included in the client’s
listing are properly classified
Balances on financial statements are
supported by details in master files and
client-prepared schedules.
Transactions near the balance sheet
Cutoff
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley date are recorded in the proper period
6 - 14
Detail tie-in
Hillsburg Hardware Co.
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance- Specific Balance-related Audit
related Audit
Objectives Applied to Inventory
Objectives
Valuation and
allocation
Accuracy
Inventory quantities on the
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
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6 - 15
Hillsburg Hardware Co.
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance- Specific Balance-related Audit
related Audit
Objectives Applied to Inventory
Objectives
Valuation and
allocation
Classification
Cutoff
Inventory items are properly
classified as to raw
materials, work in process,
and finished goods
Purchase cutoff at year end
is proper
Sales cutoff at year end is
proper
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6 - 16
Hillsburg Hardware Co.
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance- Specific Balance-related Audit
related Audit
Objectives Applied to Inventory
Objectives
Valuation and
allocation
Detail tie-in
Realizable
value
Rights and obligations Rights and
obligations
Total of inventory items
agrees with general ledger
Inventories have been written
down where net realizable
value is impaired
The company has title to all
inventory items listed
Inventories are not pledged
as collateral
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6 - 17
Assertions About
Presentation and Disclosure
Audit Objectives
Rights and obligations Rights and
obligations
Occurrence
Occurrence
Completeness
Completeness
Accuracy and
valuation
Accuracy and
valuation
Classification and
understandability
Classification and
understandability
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
Description
Client has rights to reported
Assets and is obligated to pay
on reported liabilities
Transactions and balances
presented & disclosed
exist and occurred
Presentations & disclosures that
should be included are included
Financial and other info disclosed
fairly and at appropriate amounts.
Assets are included at the
amounts estimated to be realized
Amounts classified and
presented in the proper
accounts
Financial statement
disclosures are understandable
6 - 18
Hillsburg Hardware Co.
(Applied to Inventory)
Management Assertions
About Account Balances
General Balance- Specific Balance-related Audit
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
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6 - 19
Hillsburg Hardware Co.
(Applied to Notes Payable)
Management
Assertions About
Presentation and
Disclosure
General
Presentationand Disclosurerelated Audit
Objectives
Specific Presentation and
Disclosure-related Audit Objectives
Applied to Notes Payable
Occurrence
and rights and
obligations
Occurrence
and rights and
obligations
Notes payable as described in the
footnotes exist and are
obligations of the company
Completeness
Completeness
All required disclosures related
to notes payable are included in
the financial statement footnotes
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6 - 20
Hillsburg Hardware Co.
(Applied to Notes Payable)
Management
Assertions About
Presentation and
Disclosure
General
Presentationand Disclosurerelated Audit
Objectives
Specific Presentation and
Disclosure-related Audit Objectives
Applied to Notes Payable
Valuation and
allocation
Valuation and
allocation
Footnote disclosures related to
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
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6 - 21
CAVE: Completeness, Accuracy, Valuation
and Allocation, Existence
CROC: Cutoff, Rights and Obligations,
Occurrence, Classification and
Understandability
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6 - 22
Stop!!!
If you take that piece out,
our reported assets will
be incomplete
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All transactions and events (T),
all assets, liabilities and equity
interests (B),
all disclosures (P)
that should have been recorded /
included in FS have been
6 - 23
recorded/included.
Amounts and other data relating to
recorded transactions and events
have been recorded appropriately (T).
Financial and other information are
disclosed appropriately and at
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasleyappropriate amounts. (P)
6 - 24
V&A: Assets, liabilities, and equity
interests are included in the financial
statements at appropriate amounts and
any resulting valuation adjustments are
appropriately recorded. (B)
V: Financial and other information are
disclosed appropriately and at
appropriate amounts. (P)
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6 - 25
You need to assert to
the auditors that I am an
asset at Jurassic Park
and that I exist!
Assets, liabilities, and equity interests exist. (B)
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
Not to worry Mr. T,
we’ve already asserted
that you exist, but our
auditors will still need
to physically examine
you.
6 - 26
T: Transactions and events have been
recorded in the correct accounting period.
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6 - 27
B: The entity holds or controls the rights to assets,
and liabilities are the obligation of the entity
P: Disclosed events and transactions pertain to
the entity
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6 - 28
T: Transactions and events that have been
recorded have occurred and pertain to the entity.
P: Disclosed events and transactions have
occurred.
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6 - 29
Examples: Current versus long-term; COGS versus oper. expense
Note 1
In Process Research and Development (“IPR&D”) — IPR&D
represents the fair value of the technology acquired …IPR&D is
expensed immediately upon completion of the associated
acquisition.
T: Transactions and events have been recorded in the proper accounts.
P: Financial and other information is appropriately presented and described and
disclosures are clearly expressed.
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6 - 30
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6 - 31
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6 - 32
 Sufficiency vs Appropriateness
 How can auditors increase “sufficiency”?
 How can auditors increase “appropriateness”?
Nature
(what type of evidence to get)
Timing
(when to get it)
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Extent
(how much to get
NOTE: If appropriateness 6 - 33
improves you can reduce extent)
 from knowledgeable independent sources
 or generated from effective internal controls
 directly by the auditor
 in documentary form (paper/electr.)
 In its original documentary form
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6 - 34
Existence
Completeness
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Occurrence6 - 35
F/S->Acctg data->Other info->Economic events
VOUCH for Existence and Occurrence
Vouching is an Overstatement Test
TRACE for Completeness
Tracing is an Understatement Test
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6 - 36
Explain the objective of conducting an
audit of financial statements and an
audit of internal controls.
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6 - 37
The objective of the ordinary audit of financial
statements is the expression of an opinion on
the fairness with which they present fairly, in
all respects, financial position, results of
operations, and cash flows of the entity in
conformity with GAAP.
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6 - 38
Management’s Responsibility
Is to design, implement and monitor
What is the auditor’s responsibility?
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6 - 39
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6 - 40
 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.
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6 - 41
Can the Auditor
Financial
Statements
Footnotes
Management’s Responsibility
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6 - 42
Financial
Statements
(quarterly &
Annual)
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Footnotes
6 - 43
The Sarbanes-Oxley Act provides for criminal
penalties for anyone who knowingly falsely
certifies the statements.
Sure, you bet
that is an
ASSET!!!
I don’t
think so
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6 - 44
 Explain the auditor’s responsibility for
discovering material misstatements.
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6 - 45
 Material versus immaterial misstatements
 Reasonable assurance
 Errors versus fraud
 Professional skepticism
 Fraud resulting from fraudulent financial
reporting versus misappropriation of assets
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6 - 46
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
6 - 47
Financial
Statements
Footnotes
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6 - 48
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6 - 49
Let’s just agree to leave our rental income off our
Form 1120 and our Financial Statements.
Is this a direct-effect illegal act,
or an indirect-effect illegal act?
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
6 - 50
Boy, I need a job,
I think I will apply
at Food City
Sorry, we don’t
hire bald, skinny,
white guys
Is this a direct-effect illegal act,
or an indirect-effect illegal act?
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
6 - 51
Same as for errors and fraud
Auditor evaluates whether or not there
is evidence available to indicate
material violations
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6 - 52
Indirect-effect illegal acts are the most
common
May require contingency disclosure
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6 - 53
•Read board minutes
•Request lawyer confirmation letter
• Inquire of management about policies to
prevent illegal acts and whether company
knows of any violations
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6 - 54
•Inquire of management one level up
•Consult client’s legal counsel
• Accumulate additional evidence to
determine whether illegal act exists
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6 - 55
•Consider the effects on the F/S
•If disclosures inadequate, modify report
•Consider effect of illegal act on
relationship with firm
•Can we still trust the client?
•Communicate with audit committee
•Oral or written but document in W/Ps
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6 - 56
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6 - 57
 Classify transactions and account
balances into financial statement
cycles and identify benefits of a
cycle approach to segmenting the
audit.
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6 - 58
Audits are performed by dividing the financial
statements into smaller segments or components.
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6 - 59
Transactions
Journals
Sales
Sales
journal
Cash
receipts
Cash receipts
journal
Acquisition
of goods
and services
Acquisitions
journal
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Ledgers,
Trial Balance,
and Financial
Statements
General ledger
and subsidiary
records
General ledger
trial balance
Financial
statements
6 - 60
Transactions
Cash
disbursements
Journals
Cash
disbursements
journal
Payroll
services and
disbursements
Payroll
journal
Allocation
and
adjustments
General
journal
©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley
Ledgers,
Trial Balance,
and Financial
Statements
General ledger
and subsidiary
records
General ledger
trial balance
Financial
statements
6 - 61
General
cash
Capital acquisition
and repayment cycle
Sales and
collection
cycle
Acquisition
and payment
cycle
Payroll and
personnel
cycle
Inventory and
warehousing
cycle
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6 - 62
 Explain the relationship between audit objectives
and the accumulation of audit evidence.
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6 - 63
The auditor must obtain sufficient appropriate
audit evidence to support all management
assertions in the financial statements.
As you know by now, the audit process
has four specific phases
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6 - 64
Plan and design
Phase I an audit approach
Phase II
Perform tests of
controls and
substantive tests
of transactions
Perform analytical
procedures and
Phase III tests of details
of balances
Complete the
Phase IV audit and issue
an audit report
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6 - 65
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13/e, Arens/Beasley/Elder
Arens/Elder/Beasley
6 - 66