Chapter 06 - Audit Responsibilities And objectives.pptx

AUDIT RESPONSIBILITIES AND OBJECTIVES
CHAPTER 06
Summarized, Compiled & Prepared By:
Nurun Nabi Mahmud
26th Batch, Section A
Department of Accounting & Information Systems
University of Dhaka

Learning Objective 1.
The Objective Of Conducting An Audit Of Financial Statements.
 The objective of the audit of financial statements by the independent auditor is the expression of an
opinion on the fairness with which the financial statements present financial position, results of
operations and cash flows in conformity (accordance) with respective standards.
CHAPTER 6 / AUDIT RESPONSIBILITIES AND OBJECTIVES/ ARENS_ELDER_BEASLEY_HOGAN 2

Steps To Develop Audit Objectives
 Understand objectives and responsibilities for the audit.
 Divide financial statements into cycles.
 Know management assertions about financial statements.
 Know general audit objectives for classes of transactions, accounts, and disclosures.
 Know specific audit objectives for classes of transactions, accounts, and disclosures.

Learning Objective 1l.
Management's Responsibilities In Preparing Financial Statement
 Management is responsible for:
1. Adopting and applying sound accounting policies.
2. Maintaining an adequate internal control structure.
3. Making fair presentations of financial statements.
Management’s annual report must include those three responsibilities.
 Management’s responsibility for the integrity and fairness of the presentation (assertions) in the F. S.
carries with it the privilege of determining which presentations and disclosures it considers necessarily.
 If management insists on F. S. disclosure that the auditor finds unacceptable, the auditor can either issue
an adverse or qualified opinion or withdraw from the engagement.

Learning Objective l1l.
Auditor’s Responsibilities
 AICPA auditing standards state
the overall objectives of the auditor, in conducting an audit of financial statements,
are to:
(a) obtain reasonable assurance about whether the financial statements as a whole
are free from material misstatement, whether due to fraud or error, thereby
enabling the auditor to express an opinion on whether the financial statements
are presented fairly, in all material respects, in accordance with an applicable
financial reporting framework; and
(b) report on the financial statements, and communicate as required by auditing
standards, in accordance with the auditor’s findings.

Learning Objective l1l.
Auditor’s Responsibilities
 The auditor is responsible for detecting material misstatements in the F. S.
 When the auditor also reports on the effectiveness of the internal control over financial reporting, the
auditor is also responsible for identifying material weakness in internal control over financial reporting.
 The auditor is responsible to verify financial statements and discover material errors; Irregularities and
illegal acts.
1. Auditors are responsible for designing and completing an audit as a professional in order to provide reasonable
assurance of detecting material misstatements in financial statements. but he can not guarantee or insure that
management representations are absolutely correct.
2. Audit is performed with professional method to guarantee high level of audit performance.
3. The auditor should not begin the audit assuming that management is dishonest, but the possibility of dishonesty
must be considered (professional skepticism)

The Auditor’s Responsibilities
 The auditor is responsible for obtaining reasonable assurance that material misstatements in the F.S are
detected, whether those misstatements are due to errors or fraud.
 An audit must be designed to provide reasonable assurance of detecting material misstatements in the
F.S further the audit must be planned and performed with an attitude of professional skepticism in all
aspects of the engagement. Because there is an attempt of concealment of fraud, material
misstatements due to fraud are usually more difficult to uncover (detect) than errors.
 Auditors, therefore, have less responsibility to detect irregularities than errors. The auditors best defense
when material misstatements (either errors or fraud) are not uncovered in the audit, is that the audit was
conducted in accordance with GAAS.

The related discussion in the standards about the auditor’s responsibility to detect material misstatements
include several important terms and phases:
A. Material Versus Immaterial Misstatements
B. Reasonable Assurance
C. Errors Versus Fraud
D. Professional Skepticism
E. Fraud Resulting From Fraudulent Financial Reporting Versus Misappropriation Of Assets

A. Material versus Immaterial Misstatements
 Misstatements are: errors, misappropriation (theft) of assets, and fraud in F.S.
 Misstatement is considered material when it influences F/S users’ decisions.
 It is costly and probably impossible for auditors to have responsibility for finding all errors and fraud. So
auditors are concerned with material misstatement.

B. Reasonable Assurance
 Assurance is a measure of the level of certainty that the auditor has obtained at the completion of the
audit.
 Since auditor is not an issuer of correctness of F/S, he provides a reasonable assurance about fair
presentation of F/S, not an absolute assurance.
The concept of reasonable assurance:
 It indicates that the auditor is not an insurer or guarantee of the correctness of the financial statement.
The auditor's best defense when material misstatements are not uncovered in the audit is that – audit
was conducted in accordance with GAAS.

 “The auditor is responsible for reasonable but not absolute assurance’’ for several reasons:
1. Most audit evidence results from a sample of population.
2. Accounting presentation contain complex estimate which inherently involve uncertainty and can be
affected by future events.
3. Fraudulently prepared financial statements are often extremely difficult if not impossible for the
auditor to detect especially when there is collusion among management.

C. Errors versus Fraud
 Error:
 An error is an unintentional misstatement of the financial statements.
 Error in balance sheet (Ex) quantity of inventory is not prices.
 Errors in income statement (Ex) sales invoice mistakes.
 Accounting errors (Ex) accounting errors-typed of errors by inefficient accountant such as posting in wrong side of accounting
(Easy to detect).
 The auditor can detect most cases.
 Fraud (Irregularities):
 Is an intentional misstatement of the financial statements.
 Irregularities: may be the result of either employee fraud (theft of asset)
 Example: A clerk makes theft of cash and not recode in cash register. Or management fraud (fraudulent financial reporting).
 Example: Over statement of sales near year end to increase net income auditor cannot detect or uncover all cases.
 Not that much easy to detect.

The Differences Among Errors Fraud, And Illegal Acts
Error Fraud Illegal Acts
An unintentional misstatement of
the financial statements. Example:
mistake when footing the columns
in the sales journal.
An intentional misstatement of the
financial statements.
Violation of laws or government
regulations other than fraud.
Example: dumping of toxic waste
in violations of the federal
environmental protection laws.

D. Professional Skepticism
 It consists of two primary components a questioning mind and a critical assessment of audit evidence.
 The auditor should not assume that Management is dishonest but the possibility of dishonesty must be
considered.
 The Six Characteristics or Elements of Skepticism
 Questioning mind set – a disposition to inquiry with some sense of doubt.
 Suspension of judgment – without holding judgment until appropriate evidence is obtained.
 Search for Knowledge – a desire to investigate beyond the obvious, with a desire to corroborate.
 Interpersonal understanding – recognition that people’s motivations and perceptions can lead them to provide biased or
misleading information
 Autonomy – the self-direction, moral independence, and conviction to decide for oneself, rather than accepting the
claims of others.
 Self-esteem – the self-confidence to resist persuasion and to challenge assumptions or conclusions.

Professional Judgement
 To assist auditors with maintaining an appropriate level of professional skepticism when professional
judgments are made during an audit, the profession has developed professional judgment frameworks
that illustrate an effective decision-making process and that guide auditors’ thinking to help them be
aware of their own judgment tendencies, traps, and biases.
Elements of the Judgment process
 The Center for Audit Quality’s Professional Judgment Resource outlines five key elements of a
professional judgment process, as illustrated in Figure 6-3, that auditors apply when making professional
judgments.

Financial Statement Cycle
 A common way to divide an audit is to keep closely related types (or classes) of transactions and account
balances in the same segment. This is called the cycle approach.
 For example, sales, sales returns, cash receipts, and charge-offs of uncollectible accounts are the four
classes of transactions that cause accounts receivable to increase and decrease. Therefore, they are all
parts of the sales and collection cycle. Similarly, payroll transactions and accrued payroll are parts of the
payroll and personnel cycle.
 The logic of using the cycle approach is that it ties to the way transactions are recorded in journals and
summarized in the general ledger and financial statements.

The Cycle Approach
 It is a method of dividing the audit such that closely related types of transactions and accounts balance
are included in the same cycle.
General Ledger Account Cycle
Sales Sales and Collection
Accounts Payable Acquisition and Payment
Accounts Receivables Sales and Collection
Inventory Inventory and Warehousing
Repairs and Maintenance Acquisition and Payment

Auditor’s Responsibilities For Detecting Material Errors
 Auditors spend a great portion of their time planning and performing audits to detect unintentional
mistakes made by management and employees, auditors find a variety of errors resulting from such
things as mistakes in calculations, omissions, misunderstanding and misapplication of accounting
standards, and incorrect summarizations and descriptions.
 Auditing standards make no distinction between the auditor’s responsibilities for searching for errors
and fraud. In either case, the auditor must obtain reasonable assurance about whether the statements
are free of material misstatements the standards also recognize that fraud is after more difficult detect
because management or the employees perpetrating the fraud attempt to conceal the fraud.

The Actions On Auditor Should Take When The Auditor Discovers An
Illegal Act
 The auditor should first consider the effects of the illegal act on the financial statements, including the
adequacy of disclosures, if the auditor concludes that disclosures are inadequate, the audit report should
be modified accordingly, the auditor should also consider the effect of the illegal act on its relationship
with management, and management’s trustworthiness, next the client’s audit committee of others of
equivalent authority should be informed of the illegal act, if the client does not deal with the illegal act in
a satisfactory manner, the auditor should consider withdrawing from the engagement. Finally, if the
client is publicly held, the auditor may need to report the matter to the SEC.

Misappropriation of Assets Versus Fraudulent F. Reporting
Misappropriation
 Is a theft of assets by employees ordinarily occurs either because of inadequate (IC s ) or a violation of
existing controls.
 The best way to prevent employee fraud is through adequate (IC s ) that function effectively.
 Many times employed fraud is relatively small in dollar amounts and will have no effect on the fair
presentation of F.S. there are also cases of large employee fraud that result in bankruptcy to the
company.

 Fraudulent F. reporting (Management Fraud)
 Is the intentional misstatement of financial information by management of a theft of assets by management
 Management fraud is inherently difficult to uncover because it is possible for one or more members of management to
override internal control. Irregularities may include misstatements of F.S. and theft of assets. In many cases the amounts are
extremely large and may affect the fair presentation of F.S. Also, in many cases, it is difficult to detect management fraud.
 Management Fraud is difficult to uncover because of the intended deception and efforts to make them hard to uncover by
overriding internal control instructions, omission of fraudulent transactions or recorded amounts. To uncover management
fraud, this need more cost, client cannot accept.
 Examples:
 Optimistic estimates of revenues net income to raise shares price.
 Consider some current expenses as capital expenses or types of assets.
 Old inventory prices are the same as new inventory.
 Decrease depreciation rates or percentage of allowance of doubtful debts.

 Illegal Acts:
 Are violations of laws or government regulation other than irregularities such as violation of federal tax
law (direct effect illegal acts) and violation of the federal environment protection laws (indirect effect of
illegal acts).
 Direct Effect illegal Acts
 Certain violations of laws and regulations have a direct financial effect on specific account balances in the financial
statements. For example, a violation of federal tax laws directly affects income tax expense and income taxes
payable. The auditor's responsibilities for these direct-effect illegal acts is the same as for errors and fraud.
 On each audit, therefore, the auditor will normally evaluate whether or not there is evidence available to indicate
material violations of federal or state tax laws.
 Indirect Effect Illegal Acts
 Most illegal acts affect the financial statements only indirectly. Ex: environmental laws such as decreasing
pollution.

 Auditor responsibility for illegal acts
 There are three levels of responsibility that the auditor has for finding and reporting illegal acts.
1- There is no reason to believe that there is illegal acts:
 Auditor must accumulate evidence to determine that is no reason for illegal acts.
 a) Meetings with client’s attorney.
 b) No laws or regulation violated before.
2- The auditor believed that there is reason to believe there is direct or indirect effect of illegal acts.
 Ex: Payment to consultants or government officials.
 Action to be taken:
 a) Inquires to management.
 b) Consult legal counsel or specialist.
 c) Accumulate evidence to determine illegal acts.

3- Actions when auditor knows of illegal acts:
 Consider direct effects on F.S and adequacy of disclosure.
 Find cases such as: loosing clients-loosing key employees.
 Modification of audit report.
 Communication with audit committees and management.
 Knowledge about illegal acts to be satisfied.
 Withdraw from engagement.
 Notify authorities.

Why The Auditor Obtains Assurance By Auditing Classes Of
Transactions And Ending Balances In Accounts?
 Audits are performed by dividing the financial statements into smaller segments of components. Each
segment is audited separately but not completely independently. After the audit of each segment is
completed, including interrelationship with other segments, the results are combined. A conclusion can
then be reached about the financial statements taken as a whole.

Setting Audit Objectives
Auditors conduct audits by performing audit tests of the transactions making up ending balances and also
by performing audit tests of the ending balances themselves.
Three categories of audit objectives are
 transaction-related audit objectives
 balance-related audit objectives
 presentation and disclosure-related audit objectives.

Management Assertions
 Assertion
 In general is, as explicit or implicit statement made by one party for use by another party.
 Management Assertion
 Are implied or expressed representations by management about classes of transactions and the related
accounts in the F.S. Management assertions are directly related to GAAP. These assertions are part of the
criteria that management uses to record and disclose accounting information in financial statements.
 AICPA auditing standards Classify assertions into 3 categories
1. Assertions about classes of transactions and events for the period under audit (five assertions)
2. Assertions about account balances at period end (four assertions)
3. Assertions about presentation and disclosure (four assertions)

 PCAOB auditing standards note that management implicitly or explicitly makes assertions regarding the
recognition, measurement, presentation, and disclosure of the various elements of the financial statements and
related disclosures. The PCAOB describes five categories of management assertions:
1. Existence or occurrence—Assets or liabilities of the public company exist at a given date, and recorded transactions have
occurred during the period.
2. Completeness—All transactions and accounts that should be presented in the financial statements are so included.
3. Valuation or allocation—Assets, liability, equity, revenue, and expense compoonents have been included in the financial
statements at appropriate amounts.
4. Rights and obligations—The public company holds or controls rights to the assets, and liabilities are obligations of the
company at a given date.
5. Presentation and disclosure—The components of the financial statements are properly classified, described, and
disclosed.
 These assertions are similar to the assertions in international and AICPA auditing standards, as described next.

1. Assertions About Classes Of Transactions And Events For The
Period Under Audit (Five Assertions)
Assertion Category Concept
Occurrence Concern whether recorded transactions included in the F.S. actually
occurred during the accounting period.
Completeness State the all transactions and accounts that should be presented in the F.S.
are in fact included.
Accuracy This assertion addresses whether transactions have been recorded at
correct amounts.
Classification The classification assertion addresses whether transactions are recorded in
the appropriate accounts.
Cut-off This assertion addresses whether transactions are recorded in the proper
accounting period.

2. Assertions About Account Balances
Existence Deal with whether assets, obligations and equity included in the B.S. actually
existed on the B.S. date.
Completeness State that all transactions and accounts that should be presented in the F.S.
are included
Valuation and Allocation These assertions deal with whether assets, liabilities, equity, revenues, and
expense accounts have been included in the F.S. at appropriate amounts.
Rights and Obligations Deal with whether assets are the rights of the entity and obligations of the
entity at a given date.

3. Assertions About Presentation And Disclosure Assertion Category
Occurrence and Rights And
Obligations
This assertion addresses whether disclosed events have occurred and are the
rights and obligations of the entity.
Completeness This assertion deals with whether all required disclosures have been
included in the financial statements.
Accuracy and Valuation The accuracy and valuation and allocation assertion deal with whether
financial information is disclosed fairly and at appropriate amounts.
Classification and
Understandibility
This assertion related to whether amounts are appropriately classified in the
financial statements and foot notes and whether the balance descriptions
and related disclosures are understandable.

AUDIT OBJECTIVES
 Auditor must be sure assertion are correct.
 General audit objectives follow from and are closely related to Management assertions
 General audit objective, however, are intended to provide a frame work to help the auditor accumulates
sufficient competent evidence required by the third standard at field work while Management about
classes of transactions and the related account in the F.S.
 Audit objectives more useful to auditors than assertions because they are more detailed and more
closely related to helping the auditor accumulate sufficient competent evidence.

 Audit objectives are Divided into TWO Categories
A. Transaction– Related Audit objectives
a) General
b) Specific
 Which are applicable to every class of transactions but are stated in broad- terms.
B. Balances (Specific) – Transaction – Related Audit objectives
a) General
b) Specific
 Which are also applicable to each class of transactions but are stated in terms to specific tailored to class of
transactions. EX: sales transactions.

A. Transaction– Related Audit Objectives
 Transaction – related audit objectives are closely related to management assertions.
 These objectives are used to provide a framework to help auditor in accumulating competent
sufficient evidence.

a) General Transaction Related Audit Objectives
 There are six General Transactions Related Audit Objectives.
1. Occurrence
 It deals with whether amounts included in the F.S should actually occurred (this objective is the auditor's
counterpart to the management assertion of occurrence).
2. Completeness
 Existing transactions are recorded. This objective deals with whether all transactions that should be
included in the journals have actually been included.
 The objective is the counterpart to the management assertion of completeness.

3. Accuracy
 Transactions are stated at the correct amounts.
 This objective deals with the accuracy of information for accounting transactions.
 (Ex): The quantity of goods shipped was different from billed. This objective is related to Management
assertion of valuation and allocation.
4. Classification
 Transactions included in the client's journals are properly classified. This objective is related to
Management assertion of valuation and allocation.

5. Timing
 Transactions are recorded on correct dates. This objective is related to Management assertion of
valuation and allocation A timing error occurs if transactions are not recorded on the dated the
transactions took place.
 A sales transaction, for example should be recorded on the dates of selling.
 Timing is the auditor's counterpart to management's cut-off assertion.
6. Posting and Summarizing
 Recorded transactions are properly included in the master files and are correctly summarized. This
objective deals with the accuracy of the transfer of information from recorded.
 Posting and summarizing is a part of the accuracy assertion for classes of transactions.

b) Specific Transaction–related Audit Objectives
 After the general-transactions related audit objectives are determined, specific-transactions related audit
objectives for each material class of transactions can be developed.
 Ex: Existence, completeness, accuracy, classification, timing, posting and summarizing of sales
transactions specific class of transactions.

B. Balance – Related Audit Objectives
 Resulting also from mgmt.'s assertions and provide a frame work for accumulating sufficient competent
evidence about ending balances stated in F.S.

a) General Balance-related Audit Objectives
 There are Nine General Balance-Related Audit Objectives
 a) Existence
 Ex: amounts included actually existed.
 b) Accuracy
 Ex: amounts are stated correctly.
 c) Presentation and Disclosure
 Ex: proper presentation on financial statements.
 d) Detail Tie-in
 Ex: details in account balance agree with related master file.

 e) Completeness
 EX: existing amounts are included.
 f) Classification
 EX: amounts are properly classified.
 g) Cut-off
 Ex: transactions near the balance sheet date are recorded in the proper period. h) Rights and Obligations:
Ex: amount included are owned or owed.
 i) Realizable Value
 Ex: assets are stated at the value to be realized.

How Audit Objectives Are Met?
 The auditor must obtain sufficient competent audit evidence to support all Management assertions in
the F.S to express an opinion on the fairness with the F.S present fairly in conformity with GAAP.
 To meet audit objectives, the auditor must follow ''four'' phases (or steps).
1. Plan and design an audit approach based on risk assessment procedures.
2. Perform tests of controls and substantive tests of transactions.
3. Perform analytical procedures and tests of details of balance.
4. Complete the audit and issue an audit report.

1. Plan & Design An Audit Approach
 Two overriding considerations affect the approach the auditor selects:- Sufficient appropriate evidence must be accumulated
to meet the auditor’s professional responsibility. The cost of accumulating the evidence should be minimized.
 Risk assessment: three key aspects
1. Obtain An Understanding Of The Entity And Its Environment
 Including knowledge of strategies and processes the auditor should study the client’s business model, perform analytical
procedures and make comparisons to competitors.
2. Understand Internal Control And Assess Control Risk
 The auditor identifies internal controls and evaluates their effectiveness, a process called assessing control risk.
3. Assess Risk Of Material Misstatement
 The auditor uses the understanding of the client’s industry and business strategies, as well as the effectiveness of controls, to
assess the risk misstatements in the financial statements. This assessment will then impact the audit plan and the nature,
timing, and extent of audit procedures.

2. Perform Tests Of Controls And Substantive Tests Of Transactions.
 Before auditors can justify reducing planes assessed control risk when internal controls are believed to
be effective, they must first test the effectiveness of the controls the procedures for this type of testing
are commonly referred to as tests of control.
 Auditors also evaluate the client’s recording of transactions by verifying the monetary amounts of
transactions, a process called substantive tests of transactions.

3. Perform Analytical Procedures And Tests Of Details Of Balance.
 Analytical Procedures
Consist of evaluations of financial information through analysis of plausible relationships among financial and non-
financial data.
 Tests Details Of Balances
Are specific procedures for each audit objective and for each financial statement.

4. Complete The Audit And Issue An Audit Report
 After the auditor has completed all procedures for each audit objective and for each financial statement
account and related disclosures, it is necessary to combine the information obtained to reach an overall
conclusion as to whether the financial statements are fairly presented.

ESSENTIAL TERMS
 Analytical procedures—evaluations of financial information through analysis of plausible relationships
among financial and nonfinancial data
 Balance-related audit objectives—eight audit objectives that must be met before the auditor can
conclude that any given account balance is fairly stated; the general balance related audit objectives are
existence, completeness, accuracy, classification, cutoff, detail tie-in, realizable value, and rights and
obligations
 Cycle approach—a method of dividing an audit by keeping closely related types of transactions and
account balances in the same segment
 Error—an unintentional misstatement of the financial statement

 Fraud—an intentional misstatement of the financial statements
 Fraudulent financial reporting— intentional misstatements or omissions of amounts or disclosures in
financial statements to deceive users; often called management fraud
 Management assertions—implied or expressed representations by management about classes of
transactions, related account balances, and presentation and disclosures in the financial statements
 Misappropriation of assets—a fraud involving the theft of an entity’s assets; often called defalcation
 Noncompliance with laws and regulations—failure to comply with applicable laws and regulations; often
referred to as illegal acts

 Phases of the audit process—the four aspects of a complete audit: (1) plan and design an audit
approach, (2) perform tests of controls and substantive tests of transactions, (3) perform substantive
analytical procedures and tests of details of balances, and (4) complete the audit and issue an audit
report
 Presentation and disclosure-related audit objectives—four audit objectives that must be met before the
auditor can conclude that presentation and disclosures are fairly stated; the four presentation and
disclosure-related audit objectives are occurrence and rights and obligations, completeness, accuracy
and valuation, and classification and understandability

 Professional skepticism—an attitude of the auditor that includes a questioning mind that is alert to
conditions that may indicate possible misstatement due to fraud or error, and a critical assessment of
audit evidence
 Relevant assertions—assertions that have a meaningful bearing on whether an account is fairly stated
and used to assess the risk of material misstatement and the design and performance of audit
procedures
 Risk assessment procedures—audit procedures performed to obtain an understanding of the entity and
its environment, including the entity’s internal control, to identify and assess the risks of material
misstatement
 Substantive analytical procedure—an analytical procedure in which the auditor develops an expectation
of recorded amounts or ratios to provide evidence supporting an account balance

 Substantive tests of transactions— audit procedures testing for monetary misstatements to determine
whether the six transaction-related audit objectives have been satisfied for each class of transactions
 Tests of controls—audit procedures to test the effectiveness of controls in support of a reduced assessed
control risk Tests of details of balances—audit procedures testing for monetary misstatements to
determine whether the eight balance related audit objectives have been satisfied for each significant
account balance
 Transaction-related audit objectives— six audit objectives that must be met before the auditor can
conclude that the total for any given class of transactions is fairly stated; the general transaction-related
audit objectives are occurrence, completeness, accuracy, classification, timing, and posting and
summarization

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Chapter 06 - Audit Responsibilities And objectives.pptx