AUDIT RESPONSIBILITIES AND OBJECTIVES

OBJECTIVE 6.1. Explain the objective of conducting

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

OBJECTIVE TO CONDUCTING AN AUDIT OF

FINANCIAL STATEMENTS
OBJECTIVE 6.3. Explain the auditor’s responsibility
• The preface to the clarified AICPA auditing for discovering material misstatements due to fraud
standards: or error.

AUDITOR’S RESPONSIBILITIES
The purpose of an audit is to provide financial
statement users with an opinion by the auditor on
whether the financial statements are presented AICPA auditing standards state: The overall
fairly, in all material respects, in accordance with objectives of the auditor, in conducting an audit of
the applicable financial accounting framework. An financial statements, are to:
auditor’s opinion enhances the degree of a) obtain reasonable assurance about whether
confidence that intended users can place in the the financial statements as a whole are free
financial statements. from material misstatement, whether due to
fraud or error, thereby enabling the auditor
to express an opinion on whether the
• The primary focus is on issuing an opinion on financial statements are presented fairly, in
the financial statements. all material respects with an applicable
financial reporting framework; and
The steps to develop audit objectives are listed in b) report on the financial statements, and
Figure 6-1. communicate as required by auditing
standards, in accordance with the auditor’s
1. Understand objectives and responsibilities findings.
for the audit.
2. Divide financial statements into cycles. 3. Errors versus Fraud:
Know management assertions about financial • An error is an unintentional misstatement of
statements.
the financial statements, whereas fraud is
4. Know general audit objectives for classes of
intentional.
transactions, accounts, and disclosures. 5.
Know specific audit objectives for classes of • For fraud, there is a distinction between
transactions, accounts, and disclosures. misappropriation of assets, usually
committed by employees, and fraudulent
OBJECTIVE 6.2. Distinguish management’s financial reporting, usually committed by
responsibility for the financial statements from the management.
auditor’s responsibility for verifying those
statements. Auditor’s Responsibilities for Detecting Material
Errors:
MANAGEMENT’S RESPONSIBILITIES
• Auditors spend a great portion of their time
1. Financial statements and internal controls. 2. planning and performing audits to detect
Sarbanes-Oxley increases management’s unintentional errors made by management
responsibility for the financial statements. 3. and employees.
CEO and CFO must certify quarterly, and annual
financial statements submitted to the SEC. Auditor’s Responsibilities for Detecting Material
Fraud:
Many public companies include a statement
regarding management responsibility in relation to • Auditing standards make no distinction
the CPA firm. An example of such a statement is between the auditor’s responsibilities for
included in Figure 6-2. detecting errors versus fraud.
• However, the standards do recognize that fraud is more difficult to detect because those who are committing
the fraud attempt to conceal the fraud.

Fraudulent Financial Reporting versus Misappropriation of Assets:

• Both are harmful to financial statement users. Fraudulent financial statements present users with incorrect
financial information that is used for decision making. Misappropriation of assets is harmful to creditors,
stockholders, and others because the assets have been taken from their rightful owners, the company.

AUDITOR’S RESPONSIBILITIES FOR DISCOVERING ILLEGAL ACTS

TYPE RESPONSIBILITY

Direct-Effect Same as for errors

and fraud

Indirect- Effect No Assurance

Audit Procedures When Noncompliance Is Identified or Suspected:

• The auditor should obtain an understanding of the situation and discuss the matter with management at a
level above those involved.
• Auditors should obtain sufficient evidence regarding material amounts that are directly affected by laws and
regulations.
• Laws such as those relating to taxes and pensions usually have a direct effect on the amounts or
disclosures in the financial statements, and therefore require the auditor’s attention.

Reporting Identified or Suspected Noncompliance: 1. Unless the matter is inconsequential, the auditor should
communicate with those charged with governance of matters of noncompliance.

OBJECTIVE 6.4. Describe the need to maintain professional skepticism when conducting an audit.

PROFESSIONAL SKEPTICISM

Aspects of Professional Skepticism: Two primary components:

1. A questioning mindset; and
2. A critical assessment of audit evidence.
Elements of Professional Skepticism:
1. Questioning mindset — “trust but verify” — a disposition to inquiry with some sense of doubt.
2. Suspension of judgment — withholding judgment until appropriate evidence is obtained.
3. Search for knowledge — a desire to investigate beyond the obvious, with a desire to corroborate.
4. Interpersonal understanding — recognition that people’s motivations and perceptions can lead them to
provide biased or misleading information.
5. Autonomy — the self-direction, moral independence, and conviction to decide for oneself, rather than
accepting the claims of others.
6. Self-esteem — the self-confidence to resist persuasion and to challenge assumptions or conclusions.

OBJECTIVE 6.5. Describe the key elements of an effective professional judgment process.

PROFESSIONAL JUDGMENT
• Professional judgment is part of professional skepticism.

Elements of the Judgment Process:

• Identify and define the issue.

• Gather the facts and information and identify the relevant literature.
• Perform the analysis and identify potential alternatives.

• Make the decision.

• Review and complete the documentation and rationale for the conclusion.

Some potential judgment tendencies, traps, and biases to keep in mind:

OBJECTIVE 6.6. Identify the benefits of a cycle

approach to segmenting the audit.

FINANCIAL STATEMENT CYCLES

A common form of segmenting is called the cycle

approach, which divides classes of transactions
and account balances that are closely related into
segments.

The cycles used in this text are listed below and

detailed in Figure 6-4.
• Sales and collection cycle Relationships among cycles are illustrated in Figure
6-6 below.
• Acquisition and payment cycle

• Payroll and personnel cycle

• Inventory and warehousing cycle

• Capital acquisition and repayment cycle

A trial balance is illustrated in Figure 6-5, with

accounts categorized by cycle. Cycles applied to
the trial balance are illustrated in Table 6-2.

OBJECTIVE 6.7. Describe why the auditor obtains

assurance by auditing transactions and ending
balances, including presentation and disclosure.
SETTING AUDIT OBJECTIVES
• The most efficient way to conduct audits is to
obtain some combination of assurance for
each class of transactions and for the
 ending balances in the related accounts. AICPA and IAASB standards describe three
categories of assertions:
Audit objectives for each class of transactions 1. Assertions about classes of transactions
include: and events
2. Assertions about account balances
• Transaction-related audit objectives •
3. Assertions about presentation and
Balance-related audit objectives disclosure
• Presentation and disclosure-related audit
Table 6-3 maps the PCAOB standards with the
objectives. AICPA and IAASB standards.
Figure 6.7 presents an illustration of balances and
transactions affecting the balances for Accounts
Receivable.

OBJECTIVE 6.8. Distinguish among the

management assertions about financial
information.

MANAGEMENT ASSERTIONS
• Management assertions are implied or
expressed representations by management
about classes of transactions and the related OBJECTIVE 6.9. Link transaction-related audit
accounts and disclosures in the financial objectives to management assertions for classes of
statements. transactions.
• Assertions by management are directly related
TRANSACTION-RELATED AUDIT OBJECTIVES
to the financial reporting framework (U.S.
GAAP or IFRS) that forms the criteria that
management uses to record and disclose General Transaction-Related Audit Objectives: •
accounting information in financial
statements. Occurrence — Recorded transactions exist. •
Completeness — Existing transactions are
• Management assertions lead to the audit recorded.
objectives. Therefore, auditors must have a
thorough understanding of management • Accuracy — Recorded transactions are stated
assertions to perform quality audits. at the correct amounts.

The PCAOB standards describe five categories of • Posting and Summarization — Recorded
management assertions: transactions are properly included in the
1. Existence or occurrence master files and are correctly summarized.
2. Completeness • Classification — Transactions included in the
3. Valuation or allocation
client’s journals are properly classified.
4. Rights and obligations
5. Presentation and disclosure • Timing — Transactions are recorded on the
 correct dates. amounts estimated to be realized.

Specific Transaction-Related Audit Objectives — • Rights and Obligations — Assets are owned
The specific transaction-related objectives are or controlled by the entity, and liabilities are
tailored to the specific class of transactions being obligations of the entity.
audited. Specific Balance-Related Audit Objectives — The
same as for transaction-related audit objectives,
Relationship Among Management Assertions and each balance-related audit objective should be
Transaction-Related Audit Objectives — For each tailored to the account balance being audited.
management assertion, there are general
transaction-related audit objectives as well as Relationship Among Management Assertions and
specific transaction-related audit objectives. Balance-Related Audit Objectives —These
relationships for Inventory are illustrated in Table
Table 6-4 illustrates these relationships using sales 6.5.
transactions.
Presentation and Disclosure-Related Audit
Objectives — These relationships for Notes Payable
are illustrated in Table 6-6.

OBJECTIVE 6.10. Link balance-related and

presentation and disclosure-related audit objectives
to management assertions.

BALANCE-RELATED AND PRESENTATION AND

DISCLOSURE-RELATED AUDIT OBJECTIVES

General Balance-Related Audit Objectives: •

Existence — Amounts included exist. •

Completeness — Existing amounts are
included.
• Accuracy — Amounts included are stated at OBJECTIVE 6.11. Explain the relationship between
the correct amounts. audit objectives and the accumulation of audit
evidence.
• Classification — Amounts included in the
client’s listing are properly classified. HOW AUDIT OBJECTIVES ARE MET
• Cutoff — Transactions near the balance sheet Phase I: Plan and Design an Audit Approach. The

date are recorded in the proper period. • Detail main objective of an audit is to accumulate enough
evidence to provide an opinion on the financial
Tie-In — Details in the account balance agree statements. Two overriding considerations affect
with related master file amounts, foot to the how an auditor approaches the audit:
total in the account balance, and agree with the 1. Sufficient appropriate evidence must be
total. accumulated to meet the auditor’s
• Realizable Value — Assets are included at the professional responsibility.
 2. The cost of accumulating the evidence
should be minimized.
The audit plan should result in an effective audit at
a reasonable cost.

Risk assessment procedures include the following:

• Obtain an understanding of the entity and its
environment.
• Understand internal control and assess
control risk.
• Assess risk of material misstatement.

Phase II: Perform Tests of Controls and

Substantive Tests of Transactions.
• Tests of controls allow the auditor to evaluate
the effectiveness of internal controls and
determine whether the controls can be
relied upon to reduce planned control risks.
• Substantive tests of transactions allow the
auditor to evaluate the client’s recording of
transactions.

Phase III: Perform Substantive Analytical

Procedures and Tests of Details of Balances. •
Analytical procedures consist of evaluations of
plausible relationships among financial and
nonfinancial data.
• Tests of details of balances are specific
procedures intended to test for monetary
misstatements in the financial statements.

Phase IV: Complete the Audit and Issue and Audit

Report.
• After all procedures have been completed, the
auditor will reach an overall conclusion as
to whether the financial statements are
fairly presented.
• After the conclusion, the auditor must issue
an audit report that will accompany the
client’s financial statements.