Audit Responsibilities
and Objectives
Chapter 6
©2003 Prentice Hall Business Publishing, Auditing and Assurance Services 9/e, Arens/Elder/Beasley
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Learning Objective 1
Explain the objective of
conducting an audit of
financial statements.
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Objective of Conducting an
Audit of Financial Statements
The primary objective of the audit
is to express an opinion on the
financial statements.
Plus w/ SOX 404 (AS5) – opinion on the
effectiveness of internal controls over
financial reporting
(ICFR) – public companies only!
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Steps to Develop
Audit Objectives
1
Understand objectives and
responsibilities for the audit.
2
Divide financial statements
into cycles.
3
Know management
assertions about financial statements.
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6-4
Steps to Develop
Audit Objectives
4
5
Know general audit objectives for
classes of transactions, accounts,
and disclosures.
Know specific audit objectives for
classes of transactions, accounts,
and disclosures
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Learning Objective 2
Distinguish management’s
responsibilities for the financial
statements and internal control
from the auditor’s responsibilities for
verifying the financial statements
and effectiveness of internal control.
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Responsibilities
Management is responsible
for the financial statements (prepare)
and for internal control (provide an assessment).
SOX – Mgt must now certify all f/s (10Qs and 10k)
provided to SEC. 10Qs (only review)
more reliable now? Actually no evidence!
Auditors issue an opinion on fairness
of the financial statements and an opinion on ICFR
(SOX 404 AS5). For Private Companies – Mgt
F/S and
on F/S
6-7
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Learning Objective 3
Explain the auditor’s
responsibility for discovering
material misstatements.
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6-8
Auditor’s Responsibilities
Material versus immaterial misstatements
Reasonable assurance NOT insurance. Why?
Errors versus fraud: fraudulent
financial reporting and misappropriation
of assets: Enron? Worldcom? Tyco? Adelphia?
SPEs, capitalization, Jimmy Buffett/10K shower
curtains, and a golf course on a mountain
Professional skepticism - ?s, critical, unbiased
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Responsibilities for
Discovering Illegal Acts
Direct-effect illegal acts: taxes, fine from DEP
Indirect-effect illegal acts: hiring practices
Evidence accumulation
when there is no reason
to believe indirect-effect
illegal act exists
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6 - 10
Learning Objective 4
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 - 11
Transaction Flow Example
Transactions
Journals
Sales
Sales
journal
Cash
receipts
Cash receipts
journal
Acquisition
of goods
and services
Acquisitions
journal
Ledger, Trial Balance, and
Financial Statements
General ledger
and subsidiary
records
General ledger
trial balance
Financial
statements
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6 - 12
Transaction Flow Example
Transactions
Journals
Cash
disbursements
Cash disbursements journal
Payroll
services and
disbursements
Payroll
journal
Allocation and
adjustments
General
journal
Ledger, Trial Balance, and
Financial Statements
General ledger
and subsidiary
records
General ledger
trial balance
Financial
statements
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6 - 13
Relationships Among
Transaction Cycles
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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Learning Objective 5
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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Balance and Transactions
Affecting Balances Example
Accounts Receivable (in thousands)
Cash
Beginning balance $ 19,454
Receipts
Sales
Dr. Cash
144,328
139,020
Dr. A/R
Cr. A/R
Cr. Sales
Sales returns
1,242 and allowances
3,328
Ending balance
$ 20,197
Charge-off of
uncollectible
debts
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Learning Objective 6
Distinguish among the three
categories of management
assertions about financial
information.
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Management Assertions
1. Assertions about classes of transactions and
events for the period under audit (e.g., completeness,
are all payroll transactions included in F/S?)
2. Assertions about account balances at period end
(e.g., existence – are all customer A/R balances valid?)
3. Assertions about presentation and disclosure (e.g.,
accuracy and valuation – is the breakdown of inventory
accurate?)
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Management Assertions for
Each Category of Assertions
Assertions About Classes
of Transactions and Events
Assertions About Assertions About
Account Balances Presentation and Disclosure
Occurrence
Existence
Occurrence and rights
and obligations
Completeness
Completeness
Completeness
Accuracy
Valuation and
allocation
Accuracy and
valuation
Classification
Classification and
understandability
Cutoff
Rights and
obligations
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Learning Objective 7
Link the six general transactionrelated audit objectives to
management assertions
for classes of transaction.
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General Transactions-related
Audit Objectives
Occurrence
Recorded transactions
exist
Completeness
Existing transactions
are recorded
Accuracy
(accuracy)
Recorded transactions
are stated at the
correct amounts
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General Transactions-related
Audit Objectives
Posting and
Summarization
(accuracy)
Transactions are included
in the master files and
are correctly summarized.
Classification
Transactions are properly
classified.
Timing
Transactions are recorded
on the correct dates.
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6 - 22
Management Assertions and
Transaction-related Audit Objectives
Hillsburg Hardware Company:
As 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 - 23
Management Assertions and
Transaction-related Audit Objectives
Hillsburg Hardware Company:
As 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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Learning Objective 8
Link the eight general balancerelated audit objectives to
management assertions
for account balances.
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General Balance-related
Audit Objectives
Existence
Amounts included exist
Completeness
Existing amounts are
included
Accuracy
Amounts included are
stated at the correct
amounts
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6 - 26
General Balance-related
Audit Objectives
Classification
Amounts are properly
classified
Cutoff
Transactions are recorded
in the proper period
Detail tie-in
Account balances agree
with master file amounts,
and with the general ledger
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6 - 27
General Balance-related
Audit Objectives
Realizable
value
Assets are included at
estimated realizable value
Rights and
obligations
Assets must be owned
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6 - 28
Management Assertions and
Transaction-related Audit Objectives
Hillsburg Hardware Company:
As 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 - 29
Management Assertions and
Transaction-related Audit Objectives
Hillsburg Hardware Company:
As 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 - 30
Management Assertions and
Transaction-related Audit Objectives
Hillsburg Hardware Company:
As 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 - 31
Management Assertions and
Transaction-related Audit Objectives
Hillsburg Hardware Company:
As 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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Learning Objective 9
Link the four presentation and
disclosure-related audit
objectives
to management assertions for
presentation and disclosure.
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Management Assertions and Presentation
and Disclosure-related Audit Objectives
Hillsburg Hardware Company:
As 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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Management Assertions and Presentation
and Disclosure-related Audit Objectives
Hillsburg Hardware Company:
As 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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Learning Objective 10
Explain the relationship
between audit objectives
and the accumulation
of audit evidence.
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How Audit Objectives
Are Met
The auditor must obtain sufficient appropriate
audit evidence to support all management
assertions in the financial statements.
F/S→Assertions→Objectives→Specific
Tests→Evidence→Opinion
An audit process is a methodology for organizing an
audit. No one way (why?) = judgment
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Four Phases of an Audit
Plan and design
Phase I
an audit approach.
Perform tests of
controls (SOX!)
Phase II
and substantive
tests of transactions.
Perform analytical
procedures and
Phase III
tests of details
of balances.
Phase IV
Complete the
audit and issue
an audit report.
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End of Chapter 6
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