TOPIC 2: SCOPE OF FINANCIAL STATEMENTS

AUDIT

References: Chapter 6

AUD390 2011

AUDITING AND ASSURANCE SERVICES

IN MALAYSIA

LEARNING OUTCOMES

AUD390 2011

AUDIT OBJECTIVESFRAUD, ERROR, LAWS AND REGULATIONSFINANCIAL REPORT ASSERTIONS

ASSERTIONS ABOUT CLASSES OF TRANSACTIONS

ASSERTIONS ABOUT ACCOUNT BALANCESASSERTIONS ABOUT PRESENTATION &

DISCLOSURES

AUDIT OBJECTIVES

AUD390 AUDITING DIA

ISA200: …to enable the auditor to express an opinion whether the FS are prepared, in all material respects in accordance with an identified reporting framework

Primary objective to form & express and independent expert

opinion based on the audit work performed that the FS which are to be relied upon by the users are free of material misstatements

REASONS FOR AUDIT

AUD390 AUDITING DIA

Statutory requirement under CA ActChecking on the reliability of financial

statementsProvides assurance to the users as to the truth

& fairness of financial statementsHelp owners access how well managers have

discharge their stewardship duties

MANAGEMENT’S RESPONSIBILITIES FOR THE FS

AUD390 AUDITING DIA

Responsibilities include:Preparation of financial statementsMaintaining adequate accounting records

and internal controlApply appropriate accounting policiesSafeguard of company’s assets

Management’s responsibility for the fairness of the representations (assertion) in the financial statements carries with it the privilege of determining which disclosures it considers necessary

Cont…

AUD390 AUDITING DIA

In Malaysia, it is become a practice for many public companies to include a statement about management responsibilities in the annual report (refer MAS Annual Report 2011)

In the US, the Sarbanes-Oxley Act 2002 has been established and mandatory to be complied by all organizations, large and small

Cont…

AUD390 AUDITING DIA

Sarbanes-Oxley Act 2002 (often shorten as SOX)legislation enacted in response to the high-

profile Enron and WorldCom financial scandals to protect shareholders and the general public from accounting errors and fraudulent practices in the enterprise

administered by the Securities and Exchange Commission (SEC)

sets deadlines for compliance and publishes rules on requirements

Cont…

AUD390 AUDITING DIA

Purpose: to review legislative audit requirements and to protect investors by improving the accuracy and reliability of corporate disclosures

covers issues such as establishing a public company accounting oversight board, auditor independence, corporate responsibility and enhanced financial disclosure

Area reflected management’s responsibility in SOX

It required the chief executive officer (CEO) & the chief financial officer (CFO) of public companies to certify the quarterly & annual FS submitted to SEC

Cont…

AUD390 AUDITING DIA

Certification include:FS fully comply with Securities

Exchange Act 1934 Information in the FS fairly presents

the financial condition and results of the operations

Failed to comply, e.g. falsely certifies those information, management is subject to criminal penalties, including significant monetary fines or imprisonment

AUDITOR’S RESPONSIBILITIES FOR THE FINANCIAL STATEMENTS

AUD390 AUDITING DIA

ISA200 states ~ an audit is accordance with ISAs is designed to provide reasonable assurance that the FS taken as whole are free from material misstatements

Auditor’s main responsibility is detecting material misstatements in the financial statements

Objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are free from material misstatements, which the equivalent term used are the “true and fair view” opinion

Cont…

AUD390 AUDITING DIA

MaterialityInformation is material if its omission or

misstatement could influence the economic decision of users taken on the basis of the FS

MisstatementA mistake in financial information which

would arise from errors and fraud

Cont…

AUD390 AUDITING DIA

True and Fair ViewA legal concept, but there is no legal

definition made by the court True ~ accounts must be in accordance

with facts & realityFair ~ the accounts should be unbiased,

just & equitableThe accounts considered true & fair, when

the information they contain is sufficient in quantity & quality to satisfy the reasonable expectation of the readers to whom they are addressed

Cont…

AUD390 AUDITING DIA

Reasonable Assurance Assurance ~ the level of certainty that the

auditor has obtained at the completion of the audit

Reasonable, but not absolute assurance ~ the auditor is not an insurer or guarantor of the correctness of the FS

Cont…

AUD390 AUDITING DIA

Reasons why the auditor is responsible for reasonable but not absolute assurance:1. Most audit evidence results from testing

a sample of population2. Accounting presentation contain

complex estimates, which involve uncertainty & can be affected by future events

3. Fraudulent prepared financial statements are difficult for the auditor to detect

Cont…

AUD390 AUDITING DIA

2 types of misstatements are errors & fraud Error

o Unintentional misstatement of the FSo For e.g.

1. Mistake in extending prices times quantity on sales invoice

2. Overlooking older raw materials in determining the lower of cost or market for inventory

Cont…

AUD390 AUDITING DIA

Fraudo Intentional misstatement of the FSo 2 types:

1. Misappropriation of assets, often called as defalcation or employee fraud E.g. a clerk taking cash at the time

a sale is made

Cont…

AUD390 AUDITING DIA

2. Fraudulent financial reporting, often called as management fraud E.g. intentional overstatement of sales

near the balance sheet date to increase reported earnings

Cont…

AUD390 AUDITING DIA

Professional Skepticism

FINANCIAL STATEMENT CYCLES

AUD390 AUDITING DIA

Audit are performed by dividing the financial statements into smaller segments or components

Common way ~ Cycle Approach › To keep related types (or classes) of

transactions & account balances in the same segment

› E.g. sales, sales return, cash receipt & charge-offs of uncollectible accounts are the 4 classes of transactions that cause account receivable to increase & decrease. Therefore all transactions are include in Sales & Collection Cycle

Cont…

AUD390 AUDITING DIA

CYCLE APPROACH

SALES & COLLECTION

CYCLE

ACQUASITION& PAYMENT

CYCLE

PAYROLL &PERSONNEL

CYCLE

INVENTORY &WAREHOUSING

CYCLE

CAPITALACQUASITION& REPAYMENT

CYCLE

Note: Refer Figure 6.3 & Table 6.1

AUDIT PROCESS

AUD390 AUDITING DIA

Financial Statements

ManagementAssertions

Audit Objectives

AuditPrograms

Audit Evidence

Audit Reports

FINANCIAL REPORT ASSERTIONS

AUD390 AUDITING DIA

Also known as management assertions (Arens, 2014) are defined as implied or expressed representations by management about classes of transactions and related accounts in the financial statements

Act as criteria that management uses to record and disclose accounting information in financial statements

Refer to the definition of auditing … a comparison of information (financial statements) to established criteria (assertions established according to approved accounting standards)

Cont…

AUD390 AUDITING DIA

ISA500 Audit Evidence classifies assertion into 7 categories:1. Existence2. Occurrence3. Rights and obligations4. Completeness5. Valuation or allocation6. Measurement7. Presentation and disclosure

Assertion about Existence

AUD390 AUDITING DIA

Concern whether assets, obligations and equities included in the balance sheet actually existed on the balance sheet date

Assertion about Occurrence

AUD390 AUDITING DIA

Concern whether recorded transactions included in the financial statements actually occurred during the accounting period

E.g. management asserts that recorded sales transactions represent exchanges of goods or services that actually took place

Assertion about Rights & Obligations

AUD390 AUDITING DIA

Concern whether assets are the rights of the entity & liabilities are the obligations of the entity at a given date

E.g. management assets that assets owned by the company or that amounts capitalized or leases in the balance sheet represent the cost of the entity’s rights to leased property

Assertion about Completeness

AUD390 AUDITING DIA

Concern whether all transactions and accounts that should be presented in the financial statements are included

E.g. management asserts that all sales of goods and services are recorded and included in the financial statements

Assertion about Valuation

AUD390 AUDITING DIA

Concern that whether assets, liability, equity, revenue and expense accounts have been included in the financial statements at appropriate amount

E.g. management asserts that trade account receivable included in the balance sheet are stated at net realizable value

Assertion about Measurement

AUD390 AUDITING DIA

Concern whether a transaction or event is recorded at that the proper amount & revenue and expense are allocated to the proper period

E.g. management asserts that property is recorded at historical cost and that such cost is systematically allocated to the appropriate accounting period through depreciation

Assertion about Presentation & Disclosure

AUD390 AUDITING DIA

Concern whether components of financial statements are properly combined or separated, described and disclosed

E.g. management asserts that obligations classified as long-term liabilities is the balance sheet will not mature within 1 year

Group Assignment

AUD390 AUDITING DIA

1. Define two (2) types audit objectives which are transaction-related audit objectives and balance-related audit objectives

2. Link and explain between both types of audit objectives with management assertions

Tutorial Questions

AUD390 AUDITING DIA

1. State whether you agree or disagree with the following statements? Justify your reasons.a)An auditor responsible to ensure the correctness of

the financial statement of the company.b)An auditor’s job is to ensure the correctness of the

accounting records of the company.c) An audited financial statements which has been given

a “true and fair” opinion is free from errors and misstatements.

2. Match the situation to the management assertionsa)The account and transaction that should be included

are included and the financial statements are completed.

b)Assets’ liabilities, equity, revenues and expenses are appropriately valued and are allocated to the proper accounting period.

c) Amount of assets shown in the financial statement are properly presented and disclosed.

d)The assets are the right of the entity and the liabilities are its obligations.

e)The assets and liabilities exist and the recorded transactions have occurred.