Audit_I_Chapter_4,_Pt_I,_Audit_Responsibility_and_Objectives.pptx

accounting

1. Chapter 4 Audit Responsibility, Objectives, Evidence and Documentation 4.1 Audit Responsibility & Objectives

2. Learning Objective 4.1.1 Distinguish between management’s and auditor’s responsibility 4.1.2 Explain the auditor’s responsibility for discovering material misstatements due to fraud or error . 4.1.3 Discuss the three categories of management assertions about financial information 4.1.4 Describe the need to maintain professional skepticism when conducting an audit. 4.1.5 Identify the benefits of a cycle approach to segmenting the audit . 4.1.6 Describe how audit objectives (transaction related balance related) relate to management assertions 4.1.6 Explain the relationship between audit objectives and the accumulation of audit evidence .

3. Audit Responsibility & Objective The objective of an audit of the financial statements- is an expression of an opinion on the fairness of the financial statements in all material respects. How auditor’s achieve this objective? Auditors accumulate evidence in order to reach conclusions about whether the financial statements are fairly stated and to determine the effectiveness of internal control , after which they issue the appropriate audit report. If the auditor believes that the statements are not fairly presented or is unable to reach a conclusion because o f insufficient evidence , the auditor has the responsibility of notifying users through the auditor’s report. Subsequent to their issuance, if facts indicate that the statements were not fairly presented , the auditor will probably have to demonstrate/ experess to the courts or regulatory agencies that the audit was conducted in a proper manner and the auditor reached reasonable conclusions . .

4. ..Audit Responsibility & Objective Audit I YA AAUSC 2022

5. Steps to develop an audit Objective Step 1: Understand objectives and responsibilities for the audit Management’s Responsibilities: Management of a company is responsible for Designing and implementing internal control systems effectively , A dopting sound accounting policies , and M aking fair representations in the financial statem e nts (preparing financial statements of the entity genuinely) -A company’s management knows more about the company’s transactions and related assets, liabilities, and equity more than the auditor since they operate the business daily -The auditor’s knowledge of these matters and internal control is limited to that acquired during the audit. - The management responsibility report is usually attached in the annual reports of public companies

6. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Auditor’s Responsibilities: As per ISA 200 the independent auditor is responsible: ( a)To obtain reasonable assurance - about whether the financial statements as a whole are free from material misstatement ( whether due to fraud or error ), thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework ; and (b) To report on the financial statements , and communicate as required by the ISAs, in accordance with the auditor's findings

7. … Steps to develop an audit Objective …Step 1: Understand objectives and responsibilities for the audit ….Auditor’s Responsibilities: Major points emphasized in the auditors responsibilities are: Detecting material misstatements in the financial statement Identifying material weaknesses in internal control over financial reporting. Providing reasonable assurance on the fairness of financial statements and about control systems ( For larger public companies, the auditor also issues a report on internal control over financial reporting as required by Section 404 of the Sarbanes–Oxley Act.)

8. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Material Versus Immaterial Misstatements Misstatements are usually considered material – -if the combined uncorrected errors and fraud i n the FSs would likely have changed or influenced the decisions of a reasonable person using the statements. Although it is difficult to quantify a measure of materiality, auditors are responsible for obtaining reasonable assurance that this materiality threshold has been satisfied. It would be extremely costly ( and probably impossible) for auditors to have r esponsibility for finding all immaterial errors and fraud .

9. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Reasonable Assurance Assurance - is a measure of the level of certainty that the auditor has obtained at the completion of the audit. Auditing standards indicate reasonable assurance- is a high level of assurance , but not absolute level of assurance that indicates financial statements are free of material misstatements. The concept of reasonable, but not absolute, assurance indicates that the auditor is not an insurer or guarantor of the correctness of the FSs. Thus, an audit that is conducted in accordance with auditing standards may fail to detect a material misstatement.

10. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit ….Auditor’s Responsibilities: Why the auditor is responsible for reasonable but not absolute assurance? 1. Audits are usually conducted on test basis (sampling) Sampling inevitably includes some risk of not detecting a material misstatement. Auditors may also make mistake in making judgments a bout the area to be tested, the type, extent, and timing of the tests and also evaluation of the evidences .

11. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit 2 . In accounting complex estimates are used, which inherently involve uncertainty and can be affected by future events. Because of the uncertainties involved in the estimates, an audit can not give absolute assurance 3. Fraudulently prepared financial statements are often extremely difficult, if not impossible , for the auditor to detect, especially when there is collusion among management . .

12. To conclude: It is evident that looking at each and every document is costly and will not be economical; So the auditor’s b est defense, when material misstatements are not uncovered- is to have conducted the audit in accordance with auditing standards Audit I YA AAUSC 2022

13. … Steps to develop an audit Objective .. Step 1: Understand objectives and responsibilities for the audit Errors Versus Fraud - Auditing standards distinguish between two types of misstatements : a. errors and b. fraud . - Either type of misstatement can be material or immaterial. - An error is an unintentional misstatement of the financial statements, -whereas fraud is intentional .

14. Fraud has been classified in to two: 1.Misappropriation(taking) of assets,- often called defalca`tion ( employee fraud) - eg . a clerk taking cash at the time a sale is made and not entering the sale in the cash register 2. Fraudulent financial reporting,- often called management fraud. - eg . intentional overstatement of sales near the balance sheet date to i ncrease reported earnings. Audit I YA AAUSC 2022

15. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit . Auditor’s Responsibilities for Detecting Material Errors -Auditors spend a great portion of their time in planning and performing audits to detect errors in financial statements . -Auditors find a variety of errors resulting from such things as : mistakes in calculations, omissions, misunderstanding and misapplication of accounting standards, and incorrect summarizations and descriptions.

16. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Auditor’s Responsibilities for Detecting Material Frauds Auditing standards make no distinction between the auditor’s responsibilities for searching for errors and fraud . In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detec t because management or the employees perpetrating/commit the fraud attempt to conceal the fraud.

17. Still, the difficulty of detection does not change the auditor’s responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud , so proper planning is essential Audit I YA AAUSC 2022

18. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Fraud Resulting from Fraudulent Financial Reporting Versus Misappropriation of Assets Both fraudulent financial reporting and misappropriation of assets are potentially harmful to FS users , but there is an important difference between them. Fraudulent financial reporting - harms users by providing them incorrect FS information for their decision making. When assets are misappropriated, - stockholders , creditors, and others are harmed because assets are no longer available to their rightful owners .

19. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit ….Auditor’s Responsibilities: Auditor’s responsibility to Consider non-compliance of Laws and regulations/ illegal acts (ISA 250)- : In obtaining reasonable assurance -that the financial statements are free of material misstatement , the auditor takes into account applicable legal and regulatory frameworks relevant to the -client . -For example , when auditing the FSs of a bank , the auditor would need to consider requirements of banking regulators such as r eserve requirement and others.

20. The auditor’s responsibilities regarding noncompliance with laws and regulations (called- illegal acts ) depend on whether the laws or regulations are expected to have a direct effect on the amounts and disclosures in the financial statements. illegal acts: are violations of laws or government regulations other than fraud. -Examples of illegal acts include: -violation of tax laws -violation of the environmental protection laws. Audit I YA AAUSC 2022

21. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Direct-Effect of Illegal Acts : Certain violations of laws and regulations have a direct financial effect on specific account balances in the FS. Eg . a violation of tax laws directly affects income tax expense and income taxes payable . The auditor’s responsibility for direct-effect illegal acts is the same as for errors and fraud. On each audit, the auditor should evaluate whether or not there is evidence indicating material violations of tax laws .

22. Discussions with client personnel and examining reports issued by auditors from Internal Revenue Service (after the completion of an examination of the client’s tax return) are helpful for the auditor to see if there is material violation of tax laws Audit I YA AAUSC 2022

23. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Indirect-Effect illegal Acts: - These are illegal acts that affect the financial statements only indirectly . EX . if a company violates environmental protection laws , financial statements are affected only if there is a fine or sanction . - Potential material fines and sanctions indirectly affect FSs by creating the need to disclose a contingent liability for the potential amount that might ultimately be paid. - This is called an indirect-effect illegal act. - Civil rights laws and employee safety requirements can also be sources of indirect effect legal acts

24. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit … Auditor’s responsibility to Consider Laws and regulations ISA 250 - state that the auditor provides no assurance that indirect-effect illegal acts will be detected, due to the following reasons: 1. Auditors lack legal expertise, 2. The frequent indirect relationship between illegal acts and the financial statements So it is it impractical for auditors to assume responsibility for discovering indirect-effect illegal acts.

25. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit - When the auditor believes that an illegal act may have occurred , -several actions are necessary to determine whether the suspected illegal act actually exists : 1. The auditor should first inquire of management at a level above those likely to be involved in the potential illegal act. 2. The auditor should consult with the client’s legal counsel or other specialist who is knowledgeable about the potential illegal act. 3. The auditor should consider accumulating additional evidence to determine whether there actually is an illegal act.

26. … Steps to develop an audit Objective ..Step 1: Understand objectives and responsibilities for the audit Actions When the Auditor Knows of an illegal Act 1. The first action is to consider the effects on the FSs, including the a dequacy of disclosures. Effects may be complex and difficult to resolve eg . effect of violation of civil rights laws could be significant fines, loss of customers or key employees, which could materially affect future revenues and expenses. or -If the auditor concludes that the disclosures relative to an illegal act are inadequate , the auditor should modify the audit report accordingly.

27. In deciding whether to modify/not to modify the report, the auditor should analyze the implication of the illegal act on important issues like – - the audit firm’s relationship with management, i.e - if management knew of the illegal act and failed to inform the auditor , it is questionable whether management can be believed in other discussions. Audit I YA AAUSC 2022

28. … Steps to develop an audit Objective 2. The auditor should communicate (oral or written) with the audit committee or others of equivalent authority to make sure that they know of the illegal act. - If it is oral, the nature of the communication and discussion should be documented in the audit files. -If the client either refuses to accept the auditor’s modified report or fails to take appropriate remedial actio n concerning the illegal act, the auditor may find it necessary to withdraw from the engagement . - If the client is publicly held, the auditor must also report the matter directly to the SEC. - Such decisions are complex and normally involve consultation by the auditor with the auditor’s legal counsel

29. … Steps to develop an audit Objective …..Auditor’s Responsibilities: Professional skepticism Auditor’s responsibility includes performing an audit with an attitude of professional skepticism Assignment 2-on professional judgment and skepticism –Submission date: end of discussion on Ch 4 1. Explain the concept of professional skepticism and identify its two elements 2. Describe the key elements of an effective professional judgment process. 3. List and describe the six elements of professional skepticism? 4. What are the five elements of an effective professional judgment process? 5. Describe two of the more common judgment traps and biases .

30. … Steps to develop an audit Objective Step 2: Divide Financial Statements in to Cycles Audits - are performed by dividing the financial statements into smaller segments or components. The division is needed: To make the audit more manageable and To facilitate the assignment of tasks to different members of the audit team. Eg : The audit of fixed assets and notes payable These two items may be audited in different segment separately but not on a completely independent basis. - ( eg . the audit of fixed assets may reveal an unrecorded note payable.) After the audit of each segment is completed , the results are combined . A conclusion can then be reached about the financial statements taken as a whole.

31. … Steps to develop an audit Objective …Step 2: Divide Financial Statements in to Cycles There are different ways of segmenting an audit. 1 . To treat every account balance on the statements as a separate segment. Segmenting in this way is usually inefficient. It would result in the independent audit of such closely related accounts -as inventory and cost of goods sold. 2. To use Cycle Approach to Segment an Audit It is a common way t o divide an audit It involves keeping closely related types (or classes) of transactions and account balances in the same segment

32. … Steps to develop an audit Objective …Step 2: Divide Financial Statements in to Cycles The cycle approach combines transactions recorded in different journals with the general ledger balances that result from those transactions The cycle approach divides financial statement items in to five cycles 1. Sales and collection cycle (S) 2. Acquisition and payment cycle (A) 3. Payroll and personnel cycle (P) 4. Inventory and warehousing cycle (I) 5. Capital acquisition and repayment cycle (C) 1 . Sales and collection cycle (S) -The sales and collection cycle is the first cycle listed and is a primary focus on most audits. - Collections on trade accounts receivable in the cash receipts journal is the primary operating inflow to cash in the bank.

33. … Steps to develop an audit Objective Five Classes of transactions in sales and collection cycle Accounts in each classes of transactions in sales and collection cycle 1. Sales Transaction ( Cash and on account sales) Cash, A/R, Sales 2. Cash Receipts Transaction: Collections from all sources, collection of AR with or with no discount; Cash, A/R, Sales discount, other accounts 3. Sales Returns and Allowances Transaction Sales returns and allowances and A/R 4. Write off of uncollectible A/R Transaction - Allowance for Bad debt expense, A/R 5. Estimate of Bad Debt Expense Transaction Bad debt expense, Allowance for uncollectible accounts 33 …Step 2: Divide Financial Statements in to Cycles Classes of transactions and accounts in Sales and Collection Cycle

34. … Steps to develop an audit Objective …Step 2: Divide Financial Statements in to Cycles 2. Acquisition and payment cycle (A ); Involves transactions related to : the acquisitions of goods and services used in operation the cash disbursements for those acquisitions Purchase returns & allowances, purchase discounts 3. Payroll and personnel cycle (P) Involves transactions related to Payment of salary expenses Accrual of salaries incurred but not paid Withheld of payroll related taxes, allocation of labor cost in to DL,IL

35. 4. Inventory and warehousing cycle (I) This cycle is unique because it has close relationships to other transaction cycles . Involve acquisition of raw materials, labor, and others-this relates to Acquisition & Payment cycle Involve shipping goods and record revenue and costs -this relates to Sales & Collection cycle Audit I YA AAUSC 2022

36. … Steps to develop an audit Objective ..Step 2: Divide Financial Statements in to Cycles 5. Capital acquisition and repayment cycle (C) -Transactions in the capital acquisition and repayment cycle are related to financing the business , such as issuing stock or debt , paying dividends, and repaying debt. Identifying account balances belonging to different transaction cycles It is logical to use the cycle approach since it agrees with the way transactions are recorded in journals and summarized in the general ledger and FSs. eg , Sales, Sales returns, Cash receipts, Estimate and Write-offs of Uncollectible accounts are the f ive classes of transactions that cause accounts receivable to increase and decrease . Therefore , they are all parts of the sales and collection cycle.

37. … Steps to develop an audit Objective ..Step 2: Divide Financial Statements in to Cycles Identifying account balances belonging to different transaction cycles Trial balance - is a primary focus of every audit as it is the starting point to prepare financial statements. The letter representing a cycle is shown for each account in the left column beside the account name. Note: -Each account has at least one cycle associated with it , and only cash and inventory are a part of two or more cycles. Some journals and general ledger accounts are included in more than one cycle; which shows the journal is used to record transactions from more than one cycle and indicates a tie-in between the cycles .

38. The most important general ledger account included in and affecting several cycles is general cash (cash in bank). General cash connects most cycles . Although auditors need to consider the interrelationships between cycles, they typically treat cycles independently to the extent practical to manage complex audits effectively . Audit I YA AAUSC 2022

39. … Steps to develop an audit Objective ..Step 2: Divide Financial Statements in to Cycles Activity Listed below are several accounts listed from a company's trial balance . Next to each account put the letter corresponding to the transaction cycle used to audit the account . S = Sales and collection cycle I = Inventory and warehousing cycle A = Acquisition and payment cycle C = Capital acquisition and repayment cycle P = Payroll and personnel cycle   1. ______S__ Sales returns and allowances 5. ___P_____ Salaries and commissions 2. ____ __C__ Capital stock 6. _____I___ Cost of goods sold 3. ______A__ Buildings 7. _____S___ Trade accounts receivable 4. _______C_ Notes payable 8. ___A_____ Rent

40. Steps to develop an audit Objective Step 3: Setting Audit Objectives Since the objective of an audit is to express opinion that financial statements are fairly stated , they develop audit objectives that test each management assertions Management assertions Management is responsible for the preparation of financial statements that give a true and fair view. Assertions are implied or expressed representations made by the client’s management about classes of transactions, account balances and disclosure s in the financial statements Assertions are tested by the auditor to check the different types of potential misstatements that may occur

41. Financial statements represent -management's assertions Management assertions are directly related to the financial reporting framework used by the company (usually U.S . GAAP or IFRS ) Why Assertions matter for the Auditor? The auditor’s responsibility is to determine whether management assertions - about financial statements are justified. Audit I YA AAUSC 2022

42. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives = In order to provide opinion on financial statements , it is necessary to test transactions , balances and disclosures . -Management assertions are classified in to three categories: Transaction –related assertions- Assertions about transactions and events Balance –related assertions- Assertions about account balances Disclosure –related assertions- Assertions about Disclosures

43. … Steps to develop an audit Objective Step 3: Setting Audit Objectives …..Management Assertions Management assertion related to classes of transactions .1. Occurrence. Transactions and events that have been recorded have occurred and pertain to the entity. 2 . Completeness . All transactions and events that should have been recorded have been recorded. 3. Accuracy. Amounts and other data relating to recorded transactions and events have been recorded appropriately. 4. Classification. Transactions and events have been recorded in the proper accounts. 5. Cutoff . Transactions and events have been recorded in the correct accounting period

44. … Steps to develop an audit Objective Step 3: Setting Audit Objectives Management assertion related to balances 1. Existence. Are Assets , liabilities, and equity interests exist. 2. Completeness. All assets, liabilities, and equity interests that should have been recorded have been recorded. 3. Valuation and allocation. Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation adjustments are appropriately recorded. 4. Rights and obligations. Does t he entity holds or controls the rights to assets, and liabilities are the obligation of the entity.

45. … Steps to develop an audit Objective Step 3: Setting Audit Objectives Management assertion related to presentation & disclosures 1. Occurrence and rights and obligations . Disclosed events and transactions have occurred and pertain to the entity. 2. Completeness. All disclosures that should have been included in the financial statements have been included. 4. Accuracy and valuation. Financial and other information are disclosed appropriately and at appropriate amounts. 5. Classification and understandability. Financial and other information is appropriately presented and described and disclosures are clearly expressed.

46. … Steps to develop an audit Objective - Auditors develop the following audit objectives to test management assertions: 1. Transaction-Related Audit objective- reach a conclusion that transactions are properly recorded . General transaction-related audit objectives -apply to all classes of transaction (Sales & Collection, Payment & acquisition…. Specific transaction-related audit objectives - apply to all classes of transaction but tailored to each class 2. Balance-Related Audit Objective- reach a conclusion that balances are properly stated . General balance-related audit objectives -apply to all account balances Eg Testing Existence of A/R & Inventory Specific transaction-related audit objectives - apply to all account balances but tailored to each ( Audit procedure to test existence of inventory is different from audit procedure to test existence of A/R)

47. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives The Six General Transaction Related Audit Objectives 1. Occurrence 2. Completeness 3. Accuracy 4. Posting and summarization 5. Classification 6. Timing * These transaction related audit objectives - follow related management assertion and help the auditor to accumulate sufficient appropriate evidence about transactions

48. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives The Six General Transaction Related Audit Objectives 1. Occurrence This objective deals with whether recorded transactions have actually occurred Eg Vouching recorded sales from the sales journal to the file of bills of lading. Vouching recorded expenses from the Cash payment journal to the file of check payment. Eg . inclusion of payment for expenses in cash disbursement journal when the event does not occur violates occurrence objectives This objective corresponds with management assertion of occurrence

49. … Steps to develop an audit Objective .. The Six General Transaction Related Audit Objectives 2. Completeness This objective deals with whether all transactions that should be included in the journals have actually been included Auditors account for the sequence of pre-numbered sal es invoices to check completeness Eg . F ailure to include a sales in a sales journal when a sale occurred violates the completeness objectives This objective corresponds with management assertion of completeness Occurrence is checked to see if there is overstatement Completeness is checked to see if there is understatement due to unrecorded transactions

50. … Steps to develop an audit Objective … The Six General Transaction Related Audit Objectives 3 . Accuracy This objective deals with the accuracy of information for accounting transactions Eg . in recording sales, if the quantity shipped is different from what is billed , or if wrong selling price is used , if wrong amount is recorded in sales journal , it is considered as a violation of the accuracy objectives This objective tests management’s assertion of valuation or allocation

51. … Steps to develop an audit Objective … The Six General Transaction Related Audit Objectives 4. Posting and summarization This objective involves determining whether transactions recorded in journals are transferred to the appropriate general and subsidiary ledger accounts Eg . if a receivable from customer “A” is recorded in Customer “B”s subsidiary ledger , or if the control ledger shows an amount different from the summary of subsidiary ledgers, it is considered as violation of the posting and summarization objectives This objective also tests management’s assertion of valuation or allocation The use of computerized system usually reduce this problem

52. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives ..The Six General Transaction Related Audit Objectives 5. Classification This objective involves determining whether transactions are properly coded/classified Eg . error in classifying cash sales as credit sales , recording collections from sale of operating fixed assets as revenue , Both are violation of the classification objectives 6. Timing This objective involves determining whether the transactions are recorded in the correct date the transaction take place Eg . A sales transaction should be recorded at the time of shipment (when title passes) This objective is also tests management’s assertion of valuation or allocation

53. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives The Eight General Balance Related Audit Objectives 1.Existence 2. Completeness 3.Accuracy 4. Classification 5. Cutoff 6. Detail tie-in 7. Realizable value 8. Rights and obligations These balance related objectives also follow management assertions and they provide a framework to help the auditor accumulate sufficient appropriate evidence related to account balances.

54. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives How balance related audit objectives differ from transaction related audit objectives? Balance-related objectives are almost always applied to the ending balances in balance sheet accounts Some balance-related audit object ives are applied to certain income statement accounts of non-routine nature , and unpredictable expenses such as legal expense or repairs and maintenance Income statement accounts closely related to balance sheet accounts are tested simultaneously such as ( Dep. exp with Acc dep. , interest expense with notes payable). There are eight balance related audit objectives, but only six transaction related audit objectives.

55. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives 1.Existence This objective deals with whether the amounts included in the financial statements should actually be existed Eg . inclusion of an accounts payable to a supplier that doesn’t exist in the accounts payable ledger violates the existence objectives This objective tests management assertion of existence 2. Completeness This objective deals with whether the amounts that should be included have actually been included Eg . Failure to include an accounts payable to a supplier in the accounts payable ledger when a payable exists violates the completeness objectives This objective tests management assertion of completeness

56. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives 3.Accuracy This objective deals with the arithmetic accuracy/dollar amount/ of amounts enter in the financial statements Eg . Failure to state inventory items’ correct quantity, unit cost or total cost violates the accuracy objectives This objective tests management’s assertion of valuation or allocation 4. Classification This objective involves determining whether the amounts that enter in client’s listings/classifications are in correct accounts Eg . reporting short-term investment balance under the caption ‘Receivable’ is violation of the classification objective This objective also tests part of management’s assertion of valuation or allocation

57. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives …The Eight General Balance Related Audit Objectives 5. Cutoff This objective aims to determine whether accounts in ledger reflect transactions recorded in the proper period An account balance will be misstated if transactions near the end of the accounting period are not properly recorded . This objective also tests part of management’s assertion of valuation or allocation 6. Detail tie-in (GL with SL) This objective deals about the agreement of balances in subsidiary accounts with that of the general ledger accounts Eg . if the total of subsidiary ledgers for accounts receivable do not agree with that of the accounts receivable general ledger , the detail tie-in objective is violated This objective also tests part of management’s assertion of valuation or allocation

58. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives …The Eight General Balance Related Audit Objectives 7. Realizable value (about valaution ) This objective is concerned whether asset accounts are properly valued, - i.e whether declines from historical costs are adequate Eg . - if the allowance for uncollectible account is not adequate, -If inventory write-downs for obsolete stock is not adequate, - if items that should be reported at fair value are reported at book value, this objective is not met This objective tests management’s assertion of valuation or allocation

59. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives … The Eight General Balance Related Audit Objectives 8. Rights and obligations Rights- apply for assets, and obligations- for liability Existence is not sufficient for an asset to be included in balance sheet , it has to be owned by the client’ s organization Similarly, liabilities should belong to the entity This objective tests management’s assertion of rights and obligation

60. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives The Presentation & Disclosure Related Audit Objectives The four presentation and disclosure-related audit objectives are identical to the management assertions for presentation and disclosure . The same concepts that apply to balance-related audit objectives apply equally to presentation and disclosure audit objectives 1.Occurrence and rights and obligations . Disclosed events and transactions have occurred and pertain to the entity. 2. Completeness. All disclosures that should have been included in the financial statements have been included. 4. Accuracy and valuation. Financial and other information are disclosed appropriately and at appropriate amounts. 5. Classification and understandability. Financial and other information is appropriately presented and described and disclosures are clearly expressed.

61. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives Relationships between Audit Objectives There is a significant overlap between the transaction-related and balance-related audit objectives . Rights and obligations is the only balance-related assertion withou t a similar transaction-related assertion . Presentation and disclosure-related audit objectives are closely related to the balance-related audit objectives. Auditors often consider presentation and disclosure audit objectives when addressing the balance related audit objectives .

62. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives How Audit Objectives are Met ? - The auditor must obtain sufficient appropriate audit evidence to support all management assertions in the financial statements. This is done by accumulating evidence in support of some appropriate combination of transaction-related audit objectives and balance-related audit objectives . The auditor must decide the appropriate audit objectives and the evidence to accumulate , to meet those objectives on every audit

63. … Steps to develop an audit Objective ….Step 3: Setting Audit Objectives .. How Audit Objectives are Met? To accumulate evidence that enables to achieve audit objectives, auditors follow the audit process. The audit process -= is a well-defined methodology for organizing an audit to ensure that the evidence gathered is both sufficient and appropriate and that all required audit objectives are both specified and met. - The auditor should know the legal and operating environment in which the client organization operates, and also the reporting requirement so that the audit plan can meet the objectives associated with reporting requirements in the industry

64. Four Phases of the Audit Process 1. Plan and design the audit approach 2. Perform tests of control and substantive tests of transactions 3. Perform analytical procedures and tests of details of balances 4. Complete the audit and issue an audit report Audit I YA AAUSC 2022

65. End of Chapter 4: Questions Audit I YA AAUSC 2022

66. Audit assertions Auditors need to use assertions when assessing the risk of material misstatement and designing audit procedures. How—by collecting evidence Means- auditors need to gather sufficient(how much audit evidence) and appropriate (tripe of evidence)evidence about each assertion for each transaction and account balance or disclosure. Audit I YA AAUSC 2022

67. Assertions about classes of transactions and Events P/L Statement Occurrence:- Whether transactions actually occurred during the accounting period – it happened Completeness ;- whether all transactions that should be included are in fact included Accuracy:- whether transactions have been recorded in correct journal account Classification - Whether transactions are recorded at correct amounts ( ledgers Drs and Crs ) Cutoff:- whether transactions are recorded in the proper accounting period Audit I YA AAUSC 2022

68. Assertions about account balances : Balance sheet B/S Existence: whether A, L, and E interests actually existed at the balance sheet date (are there any fake assets) Completeness: whether all the accounts that should be presented are included (liabilities concerned) Valuation (dollar value ) and allocation (Current and N/current) : whether A, L and E interests have been included at appropriate amounts Rights (ownership/control ) and obligations; whether the assets are the rights of the entity, and whether the liabilities are the obligations of the entity. Audit I YA AAUSC 2022

69. Assertions about Presentation and Disclosure This all about annual report Numbers and notes Occurrence and rights and obligation -whether disclosed events have occurred and are the rights and obligations of the entity Completeness -whether all the required disclosures have been included Accuracy and valuation; whether financial information is disclosed fairly and at appropriate amount Classification and understandability Whether amounts are appropriately classified Audit I YA AAUSC 2022

70. How do valuations Fit together Transactions Balances Occurrence Occurrence Completeness Completeness Accuracy Valuation and allocation Classification Allocation Cutoff Cutoff Audit I YA AAUSC 2022

71. General transaction related audit objectives Occurrence-did my transaction occur Completeness- did I recorded all of them Accuracy- at the right dollar value Posting and summarizing (pull to the accuracy)( technicallity of accounting)- have all these transactions posted in the right places Classification- in the right journal entry Timing(cutoff)- in the right period The first three are the key Audit I YA AAUSC 2022

72. General Balance related audit objectives Existence Completeness Valuation Classification Cutoff Detail tie- in Realizable value Rights and Obligations Audit I YA AAUSC 2022

73. Presentation and dusclosure audit objevtives Occurrence and rights and obligations Complteness Accuracy and valyaution Classification and aunderstandability Audit I YA AAUSC 2022

74. How audit objectives are met? The Auditor plans the appropriate combination of: Audit objectives The evidence that must be accumulated to meet them -This plan is called AUDIT PROGRAM (Design) Audit process is : A well defined methodology for organizing an audit to ensure that: The evidence gathered is sufficient and appropriate All audit objectives are both specified and met. Audit I YA AAUSC 2022

75. Four Phases of the Audit Process 1. Plan and design the audit approach 2. Perform tests of control and substantive tests of transactions 3. Perform analytical procedures and tests of details of balances 4. Complete the audit and issue an audit report Audit I YA AAUSC 2022