1. 5 - 1 Copyright  2003 Pearson Education Canada Inc. CHAPTER 5 Audit Responsibilities and Objectives

2. 5 - 2 Copyright  2003 Pearson Education Canada Inc. What is the objective of an audit?

3. 5 - 3 Copyright  2003 Pearson Education Canada Inc. What is the objective of an audit? An expression of opinion on the fair presentation of the financial statements in accordance with GAAP.

4. 5 - 4 Copyright  2003 Pearson Education Canada Inc. Regarding financial reporting, what are management’s responsibilities?

5. 5 - 5 Copyright  2003 Pearson Education Canada Inc. Regarding financial reporting, what are management’s responsibilities? - adopting sound accounting policies

6. 5 - 6 Copyright  2003 Pearson Education Canada Inc. Regarding financial reporting, what are management’s responsibilities? - adopting sound accounting policies - maintaining adequate internal controls

7. 5 - 7 Copyright  2003 Pearson Education Canada Inc. Regarding financial reporting, what are management’s responsibilities? - adopting sound accounting policies - maintaining adequate internal controls - ensuring fairness of financial statements

8. 5 - 8 Copyright  2003 Pearson Education Canada Inc. These responsibilities may be specified in a Management Report. ?

9. 5 - 9 Copyright  2003 Pearson Education Canada Inc. - typically includes statements regarding management’s responsibility for inter- nal controls and financial statements These responsibilities may be specified in a Management Report.

10. 5 - 10 Copyright  2003 Pearson Education Canada Inc. - typically includes statements regarding management’s responsibility for inter- nal controls and financial statements - explains operations of audit committee and Board of Directors These responsibilities may be specified in a Report of Management’s Responsibility.

11. 5 - 11 Copyright  2003 Pearson Education Canada Inc. - typically includes statements regarding management’s responsibility for inter- nal controls and financial statements - explains operations of audit committee and Board of Directors - is signed by client management and in- cluded in the company’s annual report These responsibilities may be specified in a Report of Management’s Responsibility.

12. 5 - 12 Copyright  2003 Pearson Education Canada Inc. - typically includes statements regarding management’s responsibility for inter- nal controls and financial statements - explains operations of audit committee - is signed by client management and in- cluded in the company’s annual report - not required but requested by auditor These responsibilities may be specified in a Report of Management’s Responsibility. WHY?

13. 5 - 13 Copyright  2003 Pearson Education Canada Inc. What are the auditors’ responsibilities?

14. 5 - 14 Copyright  2003 Pearson Education Canada Inc. What are the auditors’ responsibilities? - performing audit and completing report in accordance with GAAS

15. 5 - 15 Copyright  2003 Pearson Education Canada Inc. What are the auditors’ responsibilities? - performing audit and completing report in accordance with GAAS - designing the audit to provide reason- able assurance of detecting fraud, errors & irregularities that are material

16. 5 - 16 Copyright  2003 Pearson Education Canada Inc. There is much confusion among the investing public regarding auditor responsibilities. I thought auditors looked at every bit of evidence and recalculated everything!

17. 5 - 17 Copyright  2003 Pearson Education Canada Inc. There is much confusion among the investing public regarding auditor responsibilities. Auditors are responsible for designing the audit to detect material misstate- ments (which include fraud, errors and irregularities).

18. 5 - 18 Copyright  2003 Pearson Education Canada Inc. There is much confusion among the investing public regarding auditor responsibilities. BUT BUT Auditors are not responsible for finding all material fraud & other irregularities. Auditors are responsible for designing the audit to detect material misstate- ments (which include fraud, errors & irregularities).

19. 5 - 19 Copyright  2003 Pearson Education Canada Inc. Could auditors guarantee that every material fraud, error & irregularity was detected? Guarantee

20. 5 - 20 Copyright  2003 Pearson Education Canada Inc. Could auditors guarantee that every material error, fraud & irregularity was detected? Perhaps Perhaps, through a 100% audit (no samples) which would require: an army of auditors and enormous audit fees.

21. 5 - 21 Copyright  2003 Pearson Education Canada Inc. What is the difference between fraud and an illegal act?

22. 5 - 22 Copyright  2003 Pearson Education Canada Inc. fraud - individual(s) within the client organization acting against the client organization What is the difference between fraud and an illegal act?

23. 5 - 23 Copyright  2003 Pearson Education Canada Inc. fraud - individual(s) within the client organization acting against the client organization illegal act - intentional violation of law by the client organization What is the difference between fraud and an illegal act?

24. 5 - 24 Copyright  2003 Pearson Education Canada Inc. Why is auditor detection of fraud difficult?

25. 5 - 25 Copyright  2003 Pearson Education Canada Inc. - the auditor’s knowledge of client internal controls may be inferior to that of employees Why is auditor detection of fraud difficult?

26. 5 - 26 Copyright  2003 Pearson Education Canada Inc. - the auditor’s knowledge of client internal controls may be inferior to that of employees - the fraud will be intentionally concealed Why is auditor detection of fraud difficult?

27. 5 - 27 Copyright  2003 Pearson Education Canada Inc. - the auditor’s knowledge of client internal controls may be inferior to that of employees - the fraud will be intentionally concealed - client management may have the ability to override internal controls Why is auditor detection of fraud difficult?

28. 5 - 28 Copyright  2003 Pearson Education Canada Inc. The likelihood of fraud may be detected in the evaluation of internal controls: weak internal controls = greater risk of fraud

29. 5 - 29 Copyright  2003 Pearson Education Canada Inc. What are the auditors’ responsibilities regarding client illegal acts? violations of environmental laws, for example?

30. 5 - 30 Copyright  2003 Pearson Education Canada Inc. The auditor must provide reasonable assurance of detection of illegal acts that have a direct effect on the financial statements. What are the auditors’ responsibilities regarding client illegal acts?

31. 5 - 31 Copyright  2003 Pearson Education Canada Inc. The auditor must provide reasonable assurance of detection of illegal acts that have a direct effect on the financial statements. The auditor provides no assurance of detection of illegal acts that have an indirect effect on the financial statements. What are the auditors’ responsibilities regarding client illegal acts?

32. 5 - 32 Copyright  2003 Pearson Education Canada Inc. Regarding illegal acts, auditors should, in all audits, - read minutes of board meetings Minutes of Board of Directors’ Meetings Ace Company

33. 5 - 33 Copyright  2003 Pearson Education Canada Inc. - read minutes of board meetings - enquire of client’s lawyers Regarding illegal acts, auditors should, in all audits,

34. 5 - 34 Copyright  2003 Pearson Education Canada Inc. - read minutes of board meetings - enquire of client’s lawyers - enquire of client management regarding the occurrence of illegal acts AND client policies regarding illegal acts Regarding illegal acts, auditors should, in all audits,

35. 5 - 35 Copyright  2003 Pearson Education Canada Inc. What should auditors do if they suspect that an illegal act has occurred?

36. 5 - 36 Copyright  2003 Pearson Education Canada Inc. -enquire of client management at a level above those involved What should auditors do if they suspect that an illegal act has occurred?

37. 5 - 37 Copyright  2003 Pearson Education Canada Inc. -enquire of client management at a level above those involved -consult with client’s lawyer or another specialist What should auditors do if they suspect that an illegal act has occurred?

38. 5 - 38 Copyright  2003 Pearson Education Canada Inc. -enquire of client management at a level above those involved -consult with client’s lawyer or another specialist -gather evidence regarding the illegal act What should auditors do if they suspect that an illegal act has occurred?

39. 5 - 39 Copyright  2003 Pearson Education Canada Inc. What should auditors do if they know that an illegal act has occurred?

40. 5 - 40 Copyright  2003 Pearson Education Canada Inc. - consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification What should auditors do if they know that an illegal act has occurred?

41. 5 - 41 Copyright  2003 Pearson Education Canada Inc. - consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification - consider client management integrity; consult with lawyer; withdraw if appropriate What should auditors do if they know that an illegal act has occurred?

42. 5 - 42 Copyright  2003 Pearson Education Canada Inc. - consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification - consider client management integrity; consult with lawyer; withdraw if appropriate - inform audit committee or others What should auditors do if they know that an illegal act has occurred?

43. 5 - 43 Copyright  2003 Pearson Education Canada Inc. - consider effects on financial state- ments (including footnotes); if inade- quate, ask for modification - consider client management integrity; consult with lawyer; withdraw if appropriate - inform audit committee or others What should auditors do if they know that an illegal act has occurred?

44. 5 - 44 Copyright  2003 Pearson Education Canada Inc. E In an audit engagement, where does the auditor start? T N C L I

45. 5 - 45 Copyright  2003 Pearson Education Canada Inc. Would it make sense to start with the financial statements and audit each line item? In an audit engagement, where does the auditor start?

46. 5 - 46 Copyright  2003 Pearson Education Canada Inc. A better approach would be to group together similar accounts and audit each group (cycle approach). NO! grossly inefficient Would it make sense to start with the financial statements and audit each line item?

47. 5 - 47 Copyright  2003 Pearson Education Canada Inc. financial statements financial statement cycles management assertions general audit objectives specific audit objectives the cycle approach audit tests

48. 5 - 48 Copyright  2003 Pearson Education Canada Inc. financial statements financial statement cycles the cycle approach What transaction cycles and groups of accounts are relevant to this particular client?

49. 5 - 49 Copyright  2003 Pearson Education Canada Inc. financial statements financial statement cycles management assertions the cycle approach What is client’s management “asserting” about the statements, cycles, and internal controls?

50. 5 - 50 Copyright  2003 Pearson Education Canada Inc. Management assertions - existence or occurrence - financial components exist at a given date, transactions have occurred during a given period

51. 5 - 51 Copyright  2003 Pearson Education Canada Inc. - existence or occurrence - completeness - all transactions and accounts are presented, nothing has been left out Management assertions

52. 5 - 52 Copyright  2003 Pearson Education Canada Inc. - existence or occurrence - completeness - valuation or allocation - com- ponents of financial statements are included at appropriate amounts Management assertions

53. 5 - 53 Copyright  2003 Pearson Education Canada Inc. Mortgage Agreement Property Deed - existence or occurrence - completeness - valuation or allocation - rights and obligations - assets are rights of the entity and liabilities are obligations Management assertions

54. 5 - 54 Copyright  2003 Pearson Education Canada Inc. - existence or occurrence - completeness - rights and obligations - valuation or allocation - presentation and disclosure - financial statement components are properly classified, de- scribed, and disclosed Management assertions

55. 5 - 55 Copyright  2003 Pearson Education Canada Inc. } financial statements financial statement cycles management assertions general audit objectives the cycle approach Audit evidence must be gathered to support/refute management assertions. specific audit objectives

56. 5 - 56 Copyright  2003 Pearson Education Canada Inc. Transaction-related Audit Objectives related to management assertions

57. 5 - 57 Copyright  2003 Pearson Education Canada Inc. Transaction-related Audit Objectives - existence Did recorded transactions actually occur?

58. 5 - 58 Copyright  2003 Pearson Education Canada Inc. Transaction-related Audit Objectives - existence - completeness Have all transactions been recorded?

59. 5 - 59 Copyright  2003 Pearson Education Canada Inc. Transaction-related Audit Objectives - existence - completeness - accuracy Are recorded trans- actions stated at the correct amounts?

60. 5 - 60 Copyright  2003 Pearson Education Canada Inc. Transaction-related Audit Objectives - existence - completeness - accuracy - classification Are transactions properlyclassified?

61. 5 - 61 Copyright  2003 Pearson Education Canada Inc. Transaction-related Audit Objectives - existence - completeness - accuracy - classification - timing Are transactions recorded on the correct dates?

62. 5 - 62 Copyright  2003 Pearson Education Canada Inc. Transaction-related Audit Objectives - existence - completeness - accuracy - classification - timing - posting and summarization Are recorded transactions properly included in the accounting records and correctly summarized?

63. 5 - 63 Copyright  2003 Pearson Education Canada Inc. Balance-related Audit Objectives also related to management assertions

64. 5 - 64 Copyright  2003 Pearson Education Canada Inc. Balance-related Audit Objectives - existence Do amounts included in the financial statements actually exist?

65. 5 - 65 Copyright  2003 Pearson Education Canada Inc. Balance-related Audit Objectives - existence - completeness Have all amounts that should have been in- cluded in the financial statements actually been included?

66. 5 - 66 Copyright  2003 Pearson Education Canada Inc. Are financial state- ment balances in- cluded at the correct arithmetic amounts? Balance-related Audit Objectives - existence - completeness - accuracy

67. 5 - 67 Copyright  2003 Pearson Education Canada Inc. Are amounts properly classified in the correct accounts? Balance-related Audit Objectives - existence - completeness - accuracy - classification

68. 5 - 68 Copyright  2003 Pearson Education Canada Inc. Are transactions near the balance sheet date recorded in the proper period? Balance-related Audit Objectives - existence - completeness - accuracy - classification - cutoff

69. 5 - 69 Copyright  2003 Pearson Education Canada Inc. Do details in account balances agree with other related accounting information? Balance-related Audit Objectives - existence - completeness - accuracy - classification - cutoff - detail tie-in

70. 5 - 70 Copyright  2003 Pearson Education Canada Inc. When appropriate, are assets included in the financial statements at realizable value? Balance-related Audit Objectives - existence - completeness - accuracy - classification - cutoff - detail tie-in - realizable value

71. 5 - 71 Copyright  2003 Pearson Education Canada Inc. Balance-related Audit Objectives - existence - completeness - accuracy - classification - cutoff - detail tie-in - realizable value - rights and obligations Do liabilities represent actual obligations? Are assets owned?

72. 5 - 72 Copyright  2003 Pearson Education Canada Inc. Balance-related Audit Objectives - existence - completeness - accuracy - classification - cutoff - detail tie-in - realizable value - rights and obligations - presentation and disclosure Are account balances and related disclosures properly presented in the financial statements?

73. 5 - 73 Copyright  2003 Pearson Education Canada Inc. financial statements financial statement cycles management assertions general audit objectives the cycle approach How does an auditor address the specific audit objectives? specific audit objectives

74. 5 - 74 Copyright  2003 Pearson Education Canada Inc. financial statements financial statement cycles management assertions general audit objectives specific audit objectives the cycle approach obtain sufficient appropriate audit evidence

75. 5 - 75 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. III III IV

76. 5 - 76 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. II IIIIV I. Plan and design an audit approach.

77. 5 - 77 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. IIIIV I. Plan and design an audit approach. II. Perform tests of controls.

78. 5 - 78 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. II. Perform tests of controls. What are tests of controls?

79. 5 - 79 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. II. Perform tests of controls. Tests of controls examine the effective- ness of internal controls.

80. 5 - 80 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. I. Plan and design an audit approach. II. Perform tests of controls. III. Perform analyt- ical procedures and tests of details of balances. IV

81. 5 - 81 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. III. Perform analyt- ical procedures and tests of details of balances. What are analytical procedures?

82. 5 - 82 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. III. Perform analyt- ical procedures and tests of details of balances. Analytical procedures use comparisons and relation- ships to determine reasonable- ness of transactions and balances.

83. 5 - 83 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. III. Perform analyt- ical procedures and tests of details of balances. What are tests of details of balances?

84. 5 - 84 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. III. Perform analyt- ical procedures and tests of details of balances. Tests of details of balances examine monetary errors and irregularities in details of financial statements.

85. 5 - 85 Copyright  2003 Pearson Education Canada Inc. An audit can be divided into four phases. I. Plan and design an audit approach. II. Perform tests of controls. III. Perform analyt- ical procedures and tests of details of balances. IV. Complete the audit and issue an audit report.