6 the audit process. auditresponsibilities and objectives auditresponsibilities audit objective...

6666THE AUDIT PROCESSTHE AUDIT PROCESS

AUDITAUDITRESPONSIBILITIESRESPONSIBILITIESAND OBJECTIVESAND OBJECTIVES

AUDITAUDITRESPONSIBILITIESRESPONSIBILITIESAND OBJECTIVESAND OBJECTIVES

Audit ObjectiveAudit ObjectivePrimary objective of the auditis to express an opinion on thefinancial statements

Other objectives are secondaryOther objectives are secondary

FIGURE 6-1FIGURE 6-1 Steps to Develop Audit ObjectivesSteps to Develop Audit ObjectivesFIGURE 6-1FIGURE 6-1 Steps to Develop Audit ObjectivesSteps to Develop Audit Objectives

Understand objectivesand responsibilities

for the audit

Divide financialstatements

into cycles or balances

Know managementassertions about

accounts

Know general auditobjectives for

classes oftransactions and

accounts

Know specific auditobjectives for

classes oftransactions and

accounts

1

2

3

4

5

Management vs. AuditorManagement vs. AuditorResponsibilitiesResponsibilities

Management vs. AuditorManagement vs. AuditorResponsibilitiesResponsibilities

Management•Financial statement•Internal controls

Management•Financial statement•Internal controls

Auditor•Issue opinion on fairness of F/S’s

Auditor•Issue opinion on fairness of F/S’s

Distinguish management’s responsibility for the financial statements and internal control from the auditor’s responsibility for verifying the financialstatements and effectiveness of internal control. SOX requires the CEO and the CFO of public companies to certify the quarterly and annual financial statements submitted to the SEC.

Examination-Objective-Opinion-Fairness- FS Presentation

Other objectives are secondary!

Provides reasonable assurance financialstatement are free from material misstatement

Audit performed with professional skepticism

CATEGORY 1Management’s Characteristics

and Influence over theControl Environment

These pertain to management’s abilities, pressures, style, and attitude relating to internal control and the financial reporting process.

CATEGORY 2

Industry Conditions

These involve the economic and regulatory environment in which the entity operates.

CATEGORY 3

Operating Characteristicsand Financial Stability

These pertain to the nature and complexity of the entity and its transactions, financial condition, and profitability

Examples of Risk FactorsExamples of Risk Factors

• A motivation for management to engage in fraudulent financial reporting, such as an excessive interest by management to maintain or increase the entity’s stock price or earnings trend through the use of unusually aggressive accounting practices.• A failure by management to display and communicate an appropriate attitude regarding internal control and the financial reporting process, such as domination of management by a single person or small group without compensating controls.• High turnover of senior management, counsel, or board members.


• New accounting, statutory, or regulatory requirements that could impair the financial stability or profitability of the entity.• Declining industry with increasing business failures and significant declines in customer demand.• Rapid changes in the industry, such as high vulnerability to rapidly changing technology or rapid product obsolescence.


• Significant pressure to obtain additional capital necessary to stay competitive considering the financial position of the entity.• Significant, unusual, or highly complex transactions, especially those close to yearend, that pose difficult “substance over form” questions.• Overly complex organizational structure involving numerous or unusual legal entities, managerial lines of authority, or contractual arrangements without apparent business purpose.

The Three SAS 82 (SAS 99) Categories of Risk Factors for The Three SAS 82 (SAS 99) Categories of Risk Factors for Fraudulent Financial Reporting & Three Examples of EachFraudulent Financial Reporting & Three Examples of EachThe Three SAS 82 (SAS 99) Categories of Risk Factors for The Three SAS 82 (SAS 99) Categories of Risk Factors for Fraudulent Financial Reporting & Three Examples of EachFraudulent Financial Reporting & Three Examples of Each

The Two SAS 82 (SAS 99) Categories of Risk Factors for MisappropriationThe Two SAS 82 (SAS 99) Categories of Risk Factors for Misappropriation of Assets and Two Examples of Eachof Assets and Two Examples of Each

The Two SAS 82 (SAS 99) Categories of Risk Factors for MisappropriationThe Two SAS 82 (SAS 99) Categories of Risk Factors for Misappropriation of Assets and Two Examples of Eachof Assets and Two Examples of Each

CATEGORY 1CATEGORY 1

Susceptibility of AssetsSusceptibility of Assetsto Misappropriationto Misappropriation

These pertain to the nature of an entity’s assets and the degree to which they are subject to theft.

CATEGORY 2CATEGORY 2

ControlsControls

These involve the lack of controls designed to prevent or detect misappropriations of assets.


• Large amounts of cash on hand or processed• Easily convertible assets, such as bearer bonds, diamonds, or computer chips• Fixed asset characteristics, such as small size, marketability, or lack of ownership identification


• Lack of appropriate management oversight such as inadequate supervision or monitoring of remote locations• Inadequate record keeping with respect to assets susceptible to misappropriation• Lack of timely and appropriate documentation for transactions, such as credits for merchandise returns

Responsibilities for Responsibilities for Discovering Illegal ActsDiscovering Illegal Acts

• Direct-Effect Illegal Acts (same as errors & irregs)• Indirect-Effect Illegal Acts (No assurance)• Evidence Accumulation When There is No Reason to

Believe Indirect-Effect Illegal Acts exist (no resp.)• Evidence Accumulation and Other Actions When There is

Reason to Believe Direct - or Indirect-Effect Illegal ActsMay Exist (inquire, consult, consider more evidence)

• Actions when the Auditor Knows of an Illegal Act (consider f/s Effect, BOD’s/Audit Cte., collect sufficient evidence)

• Direct-Effect Illegal Acts (same as errors & irregs)• Indirect-Effect Illegal Acts (No assurance)• Evidence Accumulation When There is No Reason to

Believe Indirect-Effect Illegal Acts exist (no resp.)• Evidence Accumulation and Other Actions When There is

Reason to Believe Direct - or Indirect-Effect Illegal ActsMay Exist (inquire, consult, consider more evidence)

• Actions when the Auditor Knows of an Illegal Act (consider f/s Effect, BOD’s/Audit Cte., collect sufficient evidence)

Divide and Conquer

Audits are performed by dividing the financialstatements into smaller segments or components.

This is done using a cycle approach or a balance approach.

Sales SalesJournal

Cash Receipts CashReceipts Journal

Acquisition ofGoods & Services

AcquisitionJournal

Cash Disbursements

Cash Disbursements

Journal

Payroll Services & Disbursements Payroll Journal

Allocation and Adjustments General Journal

General Ledger and Subsidiary

Records

General Ledger Trial Balance

Financial Statements

TRANSACTIONSTRANSACTIONS JOURNALSJOURNALSLEDGERS, TRIAL BALANCES,LEDGERS, TRIAL BALANCES,AND FINANCIAL STATEMENTSAND FINANCIAL STATEMENTS

The Cycle Approach to segmenting an auditThe Cycle Approach to segmenting an auditThe Cycle Approach to segmenting an auditThe Cycle Approach to segmenting an audit

Relationships among Transaction CyclesRelationships among Transaction CyclesRelationships among Transaction CyclesRelationships among Transaction Cycles

GeneralCash

GeneralCash

Capital Acquisitionand Repayment Cycle

Capital Acquisitionand Repayment Cycle

Sales andCollection

Cycle

Sales andCollection

Cycle

Inventory andWarehousing

Cycle

Inventory andWarehousing

Cycle

Acquisition andPayment

Cycle

Acquisition andPayment

Cycle

Payroll andPersonnel

Cycle

SETTING AUDIT OBJECTIVESSETTING AUDIT OBJECTIVESSETTING AUDIT OBJECTIVESSETTING AUDIT OBJECTIVES

Balance and Transactions Affecting Those BalancesBalance and Transactions Affecting Those Balancesfor Accounts Receivablefor Accounts Receivable

Balance and Transactions Affecting Those BalancesBalance and Transactions Affecting Those Balancesfor Accounts Receivablefor Accounts Receivable

Accounts ReceivableAccounts Receivable

Beginning balance $ 96

$660Sales

Ending balance $105

$590

$ 26

$ 35

Cash receipts

Sales returnsand allowances

Charge-off ofuncollectibleaccounts

Management Assertions forEach Category of Assertions

Assertions About Classes Assertions About Classes of Transactions and Eventsof Transactions and Events

Assertions About Assertions About Account BalancesAccount Balances

Assertions About Assertions About Presentation and DisclosurePresentation and Disclosure

Occurrence Existence Occurrence and rightsand obligations

Completeness Completeness Completeness

Accuracy Valuation andallocation

Accuracy andvaluation

Classification Classification andunderstandability

Cutoff

Rights andobligations

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