Audi t Responsibilities

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Chapter 6

Audit Responsibilities and Objectives


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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


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A. Overall Objective of Financial

Statement Audit

The expression of an

opinion of the fairness

with which theypresent fairly, in all

respects, financial

position, results of

operations, and cashflows in conformity

with GAAP.


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B. Client Management

Responsibilities

Financial statements andinternal control.

Sarbanes-Oxley requiresCEO and CFO of publiccompanies to certifyquarterly and annualfinancial statements

submitted to the SEC. TheAct also provides for criminal

penalties for anyone whoknowingly falsely certifies

the statements.


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C. Auditor Responsibilities

Auditor must plan and perform

the audit to obtain

reasonable assurance

about whether the financial

statements are free ofmaterial misstatement,

whether caused by error or

fraud.


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D. Terminology

1. Material v.

Immaterial

2. ReasonableAssurance

3. Error v. Fraud

4. Professional

Skepticism


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1. Material v. Immaterial

Misstatements are usually

considered material if the

combined uncorrected errors

and fraud in the financialstatements 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.


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2. Reasonable Assurance

Auditors can not guarantee thatthere are no material

misstatements because:

Auditors use judgment based onsamples. Errors in judgment canoccur.

Accounting presentations are

based on complex estimates thatinvolve uncertainty.

Fraudulently prepared financialstatements are difficult to detect,

especially if there is collusion.


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3. Error v. Fraud

An error is anunintentional

misstatement of the

financial statements,whereas fraud is

intentional.

For fraud, there is adistinction betweenmisappropriation of

assets and fraudulentfinancial reporting.


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4. Professional Skepticism Audit should bedesigned to provide

reasonable assuranceof detecting both

material errors andfraud in the financial

statements. Although an auditorshould not assume that

management is

dishonest, the possibilityof dishonesty must also

be considered.


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II. Categories of Fraud

A. Fraudulent Financial Reporting

B. Misappropriation of Assets


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A. Fraudulent Financial Reporting

Fraudulent financial reporting is often committedby management.

Harms users of the financial statements by

providing incorrect information. Survey results indicate that some of the most

common techniques to misstate financialstatements are:

Recording revenues prematurelyRecording fictitious revenue

Overstatement of assets such as receivables,inventory, etc.


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B. Misappropriation of Assets

Often perpetrated byemployees and

sometimes

management. Harms investors

because assets are nolonger available.

Misappropriations oftenresult in fraudulent

financial reporting tohide the theft.


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III. Auditor Responsibility for

Detection of Illegal Acts

A. Direct-Effect Illegal Acts

B. Indirect-Effect Illegal Acts

C. Evidence Accumulation When There isSuspicion of Illegal Acts

D. Auditor Actions for Known Illegal Acts

SAS 54 defines illegal acts as violations of laws

or government regulations other than fraud.


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C. Evidence Accumulation When

There is Suspicion of Illegal Acts

Auditor should inquire of management at a levelabove those likely to be involved.

Auditor should consult with the clients legal

counsel who is knowledgeable about thepotential illegal act.

Auditor should consider accumulating additionalevidence to determine whether there actually is

an illegal act.


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D. Auditor Actions for Known

Illegal Acts Consider the effects on

the financial statements.

Consider the effect onmanagement

representations. Communicate with the

audit committee.

Report the matter to theSEC after consultationwith the auditors legal

counsel.


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IV. Managing the Audit Process

A. The Cycle Approach

B. The Testing of Client Assertions


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A. The Cycle Approach

A common way to divide an audit is to keepclosely 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


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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.

2. Existence or occurrence

4. Completeness3. Rights and obligations

5. Valuation or allocation

1. Presentation and disclosure


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1. Presentation and Disclosure

Management Represents Auditor Tests

Financial statementcomponents are

properly combined or

separated, described

and disclosed.

Auditor tests whetherfinancial statements are

presented in accordance

with GAAP.


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2. Existence or Occurrence


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 for

overstatement of items


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3. Rights and Obligations


Client organization

possesses ownershiprights to recorded assets.

Client records show

liabilities owed as of the

balance sheet date.

Auditor tests asset

ownership and liability

claims.


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5. Valuation or Allocation


All asset, liability, equity,revenue, and expense

accounts have been

included in the financial

statements at appropriateamounts.

Auditor tests whether

account balances are valued

and allocated in accordance

with GAAP.


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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 TransactionsC. Phase III Analytical Procedures and Test of

Details of Balances

D. Phase IV - Complete the Audit and Issue anAudit Report


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A. Phase I Plan and Design an

Audit Approach

Two key aspects are imperative in the planning

process:

Obtain knowledge the clients businessstrategies and processes and assess risks. This

is used to help assess the risk of misstatement

in the financial statements.

Understand internal control and assess controlrisk. Strong internal controls may justify less

accumulation of evidence.


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B. Phase II Tests of Controls and

Substantive Tests of Transactions

Control risk is the risk that internal controls willfail to catch inappropriate information reporting.To justify reducing the planned assessed control

risk when internal controls are strong, theauditor 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 oftransactions.


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D Ph IV C l t th A dit


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D. Phase IV Complete the Audit

and Issue a Report

After completion ofthe audit work, it is

necessary to combine

the informationobtained and decide if

the financialstatements are fairly

stated. Appropriate report is

then written.


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Summary

1. Client and auditor responsibilities

2. Fraudulent financial reporting vs.

misappropriation of assets.

3. Testing client assertions

4. Phases of the audit process

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Audi t Responsibilities