Transcript Chapter 6 Audit Responsibilities and Objectives Presentation Outline I. Financial Statement Responsibilities II.

Chapter 6
Audit Responsibilities and Objectives
Presentation Outline
I. Financial Statement Responsibilities
II. Categories of Fraud
III. Auditor Responsibility for Detection of Illegal
Acts
IV. Managing the Audit Process
V. Phases of the Audit Process
I. Financial Statement
Responsibilities
A. Overall Objective of Financial Statement Audit
B. Client Management Responsibilities
C. Auditor Responsibilities
D. Terminology
A. Overall Objective of Financial
Statement Audit
The expression of an
opinion of the fairness
with which they
present fairly, in all
respects, financial
position, results of
operations, and cash
flows in conformity
with GAAP.
B. Client Management
Responsibilities
Financial statements and
internal control.
 Sarbanes-Oxley requires
CEO and CFO of public
companies to certify
quarterly and annual
financial statements
submitted to the SEC. The
Act also provides for criminal
penalties for anyone who
knowingly falsely certifies
the statements.

C. Auditor Responsibilities
Auditor must plan and perform
the audit to obtain
reasonable assurance
about whether the financial
statements are free of
material misstatement,
whether caused by error or
fraud.
D. Terminology
1. Material v.
Immaterial
2. Reasonable
Assurance
3. Error v. Fraud
4. Professional
Skepticism
1. Material v. Immaterial
Misstatements are usually
considered material if the
combined uncorrected errors
and fraud in the financial
statements would influence a
reasonable person using the
statements.
 It would be extremely costly
and probably impossible to hold
the auditor accountable for
immaterial errors and fraud.

2. Reasonable Assurance


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Auditors can not guarantee that
there are no material
misstatements because:
Auditors use judgment based on
samples. Errors in judgment can
occur.
Accounting presentations are
based on complex estimates that
involve uncertainty.
Fraudulently prepared financial
statements are difficult to detect,
especially if there is collusion.
3. Error v. Fraud
An error is an
unintentional
misstatement of the
financial statements,
whereas fraud is
intentional.
 For fraud, there is a
distinction between
misappropriation of
assets and fraudulent
financial reporting.

4. Professional Skepticism
Audit should be
designed to provide
reasonable assurance
of detecting both
material errors and
fraud in the financial
statements.
 Although an auditor
should not assume that
management is
dishonest, the possibility
of dishonesty must also
be considered.

II. Categories of Fraud
A. Fraudulent Financial Reporting
B. Misappropriation of Assets
A. Fraudulent Financial Reporting

Fraudulent financial reporting is often committed
by management.
 Harms users of the financial statements by
providing incorrect information.
 Survey results indicate that some of the most
common techniques to misstate financial
statements are:
Recording revenues prematurely
Recording fictitious revenue
Overstatement of assets such as receivables,
inventory, etc.
B. Misappropriation of Assets
Often perpetrated by
employees and
sometimes
management.
 Harms investors
because assets are no
longer available.
Misappropriations often
result in fraudulent
financial reporting to
hide the theft.


III. Auditor Responsibility for
Detection of Illegal Acts
SAS 54 defines illegal acts as violations of laws
or government regulations other than fraud.
A. Direct-Effect Illegal Acts
B. Indirect-Effect Illegal Acts
C. Evidence Accumulation When There is
Suspicion of Illegal Acts
D. Auditor Actions for Known Illegal Acts
A. Direct Effect Illegal Acts
Certain illegal acts
directly affect specific
account balances.
For example, violation
of federal tax laws.
 Auditor responsibility
for direct-effect illegal
acts is the same as
for errors and fraud.

B. Indirect-Effect Illegal Acts
Indirect-effect illegal
acts do not affect
financial statements
directly, but result in
potential fines.
 Auditing standards
clearly state that
auditors provide no
assurance that such
illegal acts will be
detected.

C. Evidence Accumulation When
There is Suspicion of Illegal Acts

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Auditor should inquire of management at a level
above those likely to be involved.
 Auditor should consult with the client’s legal
counsel who is knowledgeable about the
potential illegal act.
Auditor should consider accumulating additional
evidence to determine whether there actually is
an illegal act.
D. Auditor Actions for Known
Illegal Acts
Consider the effects on
the financial statements.
 Consider the effect on
management
representations.
 Communicate with the
audit committee.
 Report the matter to the
SEC after consultation
with the auditor’s legal
counsel.

IV. Managing the Audit Process
A. The Cycle Approach
B. The Testing of Client Assertions
A. The Cycle Approach
A common way to divide an audit is to keep closely
related types of transactions and account
balances in the same segment. The following
segments exist in many businesses:
Sales and collection
Acquisition and payment
Payroll and personnel
Inventory and warehousing
Capital acquisition and repayment
B. The Testing of Client
Assertions
Management assertions are implied or expressed
representations by client management about classes
of transactions and related accounts in the financial
statements.
1. Presentation and disclosure
2. Existence or occurrence
3. Rights and obligations
4. Completeness
5. Valuation or allocation
1. Presentation and Disclosure
Management Represents
Auditor Tests
Financial statement
components are
properly combined or
separated, described
and disclosed.
Auditor tests whether
financial statements are
presented in accordance
with GAAP.
2. Existence or Occurrence
Management Represents
 Existence is concerned
with whether assets,
obligations, and equities
included in the balance
sheet actually existed on
the balance sheet date.
 Transactions recorded
occurred during the
accounting period.
Auditor Tests
Auditor tests for
overstatement of items
3. Rights and Obligations
Management Represents
 Client organization
possesses ownership
rights to recorded assets.
 Client records show
liabilities owed as of the
balance sheet date.
Auditor Tests
Auditor tests asset
ownership and liability
claims.
4. Completeness
Management Represents
All transactions and
accounts that should be
presented in the
financial statements are
included.
Auditor Tests
Auditor tests for
understatement of items
5. Valuation or Allocation
Management Represents
Auditor Tests
All asset, liability, equity,
revenue, and expense
Auditor tests whether
accounts have been
account balances are valued
included in the financial and allocated in accordance
statements at appropriate
with GAAP.
amounts.
V. The Phases of the Audit
Process
A. Phase I – Plan and Design an Audit Approach
B. Phase II – Tests of Controls and Substantive
Tests of Transactions
C. Phase III – Analytical Procedures and Test of
Details of Balances
D. Phase IV - Complete the Audit and Issue an
Audit Report
A. Phase I – Plan and Design an
Audit Approach
Two key aspects are imperative in the planning
process:
Obtain knowledge the client’s business
strategies and processes and assess risks. This
is used to help assess the risk of misstatement
in the financial statements.
Understand internal control and assess control
risk. Strong internal controls may justify less
accumulation of evidence.
B. Phase II – Tests of Controls and
Substantive Tests of Transactions
Control risk is the risk that internal controls will
fail to catch inappropriate information reporting.
To justify reducing the planned assessed control
risk when internal controls are strong, the
auditor must test compliance with controls.
Depending on the assessed level of control risk,
the auditor will then perform substantive testing
of transactions to verify the monetary amounts of
transactions.
C. Phase III – Analytical Procedures and Tests
of Details of Balances
Analytical procedures use comparisons and
relationships to assess whether account
balances or other data appear reasonable.
Tests of details of balances involve specific
procedures to test for the monetary
misstatement of balances in the financial
statements. Most of this evidence comes from a
source outside of the client.
D. Phase IV – Complete the Audit
and Issue a Report
After completion of
the audit work, it is
necessary to combine
the information
obtained and decide if
the financial
statements are fairly
stated.
 Appropriate report is
then written.

Summary
1. Client and auditor responsibilities
2. Fraudulent financial reporting vs.
misappropriation of assets.
3. Testing client assertions
4. Phases of the audit process