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Audit

Responsibilities
and Objectives

Chapter 6

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6-1


Learning Objective 1

Explain the objective of


conducting an audit of
financial statements and
an audit of internal controls.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6-2


Objective of Conducting an Audit
of Financial Statements

The objective of the ordinary audit of financial


statements is the expression of an opinion of
the fairness with which they present fairly, in
all respects, financial position, result of
operations, and its cash flows in
conformity with GAAP.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6-3


Steps to Develop Audit Objectives

Understand objectives and


1
responsibilities for the audit.

Divide financial statements


2
into cycles.

Know management
3
assertions about accounts.

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Steps to Develop Audit Objectives

Know general audit objectives for


4
classes of transactions and accounts.

Know specific audit objectives for


5
classes of transactions and accounts.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6-5


Learning Objective 2
Distinguish managements
responsibility for the financial
statements and internal control
from the auditors responsibility
for verifying the financial
statements and effectiveness
of internal control.
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6-6
Managements Responsibilities

Management is responsible for the financial


statements and for internal control.

The SarbanesOxley Act increases managements


responsibility for the financial statements.

It requires the CEO and the CFO of public


companies to certify the quarterly and annual
financial statements submitted to the SEC.

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Managements Responsibilities

The Sarbanes-Oxley Act provides for criminal


penalties for anyone who knowingly falsely
certifies the statements.

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Learning Objective 3

Explain the auditors


responsibility for discovering
material misstatements.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6-9


Auditors Responsibilities

Material versus immaterial misstatements


Reasonable assurance
Errors versus fraud
Professional skepticism
Fraud resulting from fraudulent financial
reporting versus misappropriation of assets

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 10


Auditors Responsibilities for
Discovering Illegal Acts

Direct-effect illegal acts

Indirect-effect illegal acts

Evidence accumulation when there is no reason


to believe indirect-effect illegal act exists

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 11


Auditors Responsibilities for
Discovering Illegal Acts

Evidence accumulation and other actions


when there is reason to believe direct- or
indirect-effect illegal acts may exist

Actions when the auditor knows of an illegal act

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 12


Learning Objective 4

Classify transactions and account


balances into financial statement
cycles and identify benefits of a
cycle approach to segmenting
the audit.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 13


Financial Statements Cycles

Audits are performed by dividing the financial


statements into smaller segments or components.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 14


Transaction Flow Example
Ledgers,
Transactions Journals Trial Balance,
and Financial
Sales Statements
Sales
journal
General ledger
and subsidiary
records
Cash Cash receipts
receipts journal
General ledger
trial balance
Acquisition
Acquisitions
of goods
journal Financial
and services
statements

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 15


Transaction Flow Example
Ledgers,
Transactions Journals Trial Balance,
and Financial
Cash Statements
Cash
disbursements
disbursements
journal General ledger
and subsidiary
records
Payroll
Payroll
services and
journal
disbursements General ledger
trial balance
Allocation
General
and
journal Financial
adjustments
statements

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 16


Relationships Among Transaction
Cycles
General
cash

Capital acquisition
and repayment cycle

Sales and Acquisition Payroll and


collection and payment personnel
cycle cycle cycle

Inventory and
warehousing
cycle
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Learning Objective 5

Describe why the auditor obtains


a combination of assurance by
auditing class of transactions and
ending balances in accounts.

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Balance and Transactions
Affecting Balances Example
Accounts Receivable (in thousands)
Beginning balance $ 17,521

Sales $144,328 $137,087 Cash receipts

Sales returns
$ 1,242 and allowances

Charge-off of
$ 3,323 uncollectible
accounts

Ending balance $ 20,197


2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 19
Learning Objective 6

Distinguish among the five


categories of management
assertions about financial
information.

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Management Assertions

1. Existence or occurrence

2. Completeness

3. Valuation or allocation

4. Rights and obligations

5. Presentation and disclosure

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Learning Objective 7

Link the six general transaction-


related audit objectives to the
five management assertions.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 22


Transaction-Related Audit
Objectives and Management
Assertions General Transaction-
Management Assertions Related Audit Objectives
Existence or occurrence Existence
Completeness Completeness
Accuracy
Classification
Valuation or allocation
Timing
Posting and summarization
Rights and obligations N/A
Presentation and disclosure N/A
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 23
Transaction-Related Audit
Objectives and Management
Assertions
Recorded transactions
Existence
exist.

Existing transactions are


Completeness
recorded.

Recorded transactions
Accuracy are stated at the
correct amounts.
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 24
Transaction-Related Audit
Objectives and Management
Assertions
Transactions are properly
Classification
classified.

Transactions are recorded


Timing
on the correct dates.

Transactions are included


Posting and
in the master files and
summarization
are correctly summarized.
2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 25
Learning Objective 8

Link the nine general balance-


related audit objectives to the
five management assertions.

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Assertions and Balance-Related
Audit Objectives
General Balance
Management Assertions Related Audit Objectives
Existence or occurrence Existence
Completeness Completeness
Accuracy
Classification
Valuation or allocation
Cut-off, Detail tie-in
Realizable value
Rights and obligations Rights and obligations
Presentation and disclosure Presentation and disclosure

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 27


General Balance-Related
Audit Objectives

Existence Amounts included exist.

Existing amounts are


Completeness
included.

Amounts included are


Accuracy stated at the correct
amounts.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 28


General Balance-Related
Audit Objectives

Amounts are properly


Classification
classified.

Transactions are recorded


Cutoff
in the proper period.

Account balances agree


Detail tie-in with master file amounts,
and with the general ledger.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 29


General Balance-Related
Audit Objectives

Realizable Assets are included at


value estimated realizable value.

Rights and
Assets must be owned.
obligations

Presentation Account balances and


and disclosures are presented
disclosure in financial statements.

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Learning Objective 9

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 competent


audit evidence to support all management
assertions in the financial statements.

An audit process is a methodology


for organizing an audit.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 32


Four Phases of a Financial
Statement Audit
Perform analytical
Plan and design procedures and
Phase I an audit approach. Phase III tests of details
of balances.

Perform tests of
Complete the
controls and
Phase II substantive tests Phase IV audit and issue
an audit report.
of transactions.

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 33


End of Chapter 6

2006 Prentice Hall Business Publishing, Auditing 11/e, Arens/Beasley/Elder 6 - 34

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