1. ©2010 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6 - 1 Audit Responsibilities and Objectives Chapter 6

2. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 2 Learning Objective 1 Explain the objective of conducting an audit of financial statements and an audit of internal controls.

3. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 3 Objective of Conducting an Audit of Financial Statements The objective of the ordinary audit of financial statements is the expression of an opinion of the fairness with which they present fairly, in all respects, financial position, result of operations, and its cash flows in conformity with GAAP.

4. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 4 Steps to Develop Audit Objectives

5. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 5 Steps to Develop Audit Objectives 4.Know general audit objectives for classes of transactions and accounts. 5.Know specific audit objectives for classes of transactions, accounts and disclosures.

6. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 6 Learning Objective 2 Distinguish management’s responsibility for the financial statements and internal control from the auditor’s responsibility for verifying the financial statements and effectiveness of internal control.

7. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 7 Management’s Responsibilities Management’s Responsibilities Management is responsible for the financial statements and for internal control. The Sarbanes-Oxley Act increases management’s responsibility for the financial statements. It requires the CEO and the CFO of public companies to certify the quarterly and annual financial statements submitted to the SEC.

8. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 8 Management’s Responsibilities Management’s Responsibilities The Sarbanes-Oxley Act provides for criminal penalties for anyone who knowingly falsely certifies the statements.

9. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 9 Learning Objective 3 Explain the auditor’s responsibility for discovering material misstatements.

10. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 10 Auditor’s Responsibilities  Material versus immaterial misstatements  Reasonable assurance  Errors versus fraud  Professional skepticism  Fraud resulting from fraudulent financial reporting versus misappropriation of assets

11. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 11 Auditor’s Responsibilities for Discovering Illegal Acts  Direct-effect illegal acts  Indirect-effect illegal acts  Evidence accumulation when there is no reason to believe indirect-effect illegal act exists

12. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 12 Auditor’s Responsibilities for Discovering Illegal Acts  Evidence accumulation and other actions when there is reason to believe direct- or indirect-effect illegal acts may exist  Actions when the auditor knows of an illegal act

13. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 13 Learning Objective 4 Classify transactions and account balances into financial statement cycles and identify benefits of a cycle approach to segmenting the audit.

14. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 14 Financial Statements Cycles Audits are performed by dividing the financial statements into smaller segments or components.

15. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 15 Transaction Flow Example Ledgers, Trial Balance, and Financial Statements General ledger and subsidiary records General ledger trial balance Financial statements Acquisition of goods and services Sales Cash receipts Transactions Cash receipts journal Sales journal Acquisitions journal Journals

16. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 16 Transaction Flow Example Allocation and adjustments Cash disbursements Payroll services and disbursements Ledgers, Trial Balance, and Financial Statements General ledger and subsidiary records General ledger trial balance Financial statements Transactions Payroll journal Cash disbursements journal General journal Journals

17. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 17 Relationships Among Transaction Cycles General cash Capital acquisition and repayment cycle Sales and collection cycle Acquisition and payment cycle Payroll and personnel cycle Inventory and warehousing cycle

18. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 18 Learning Objective 5 Describe why the auditor obtains a combination of assurance by auditing classes of transactions and ending balances in accounts, including presentation and disclosure.

19. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 19 Balance and Transactions Affecting Balances Example Beginning balance Sales $ 17,521 $144,328$137,087 Cash receipts $ 1,242 Sales returns and allowances Charge-off of uncollectible accounts Ending balance$ 20,197 $ 3,323 Accounts Receivable (in thousands)

20. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 20 Learning Objective 6 Distinguish among the three categories of management assertions about financial information.

21. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 21 Management Assertions 1.Assertions about classes of transactions and events for the period under audit 2. Assertions about account balances at period end 3. Assertions about presentation and disclosure

22. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 22 Management Assertions for Each Category of Assertions Assertions About Classes of Transactions and Events Assertions About Account Balances Assertions About Presentation and Disclosure OccurrenceExistenceOccurrence and rights and obligations Completeness AccuracyValuation and allocation Accuracy and valuation ClassificationClassification and understandability Cutoff Rights and obligations

23. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 23 Learning Objective 7 Link the six general transaction- related audit objectives to management assertions for classes of transactions.

24. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 24 Occurrence Recorded transactions exist Completeness Existing transactions are recorded Accuracy Recorded transactions are stated at the correct amounts General Transactions-related Audit Objectives

25. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 25 Classification Transactions are properly classified. Timing Transactions are recorded on the correct dates. Posting and summarization Transactions are included in the master files and are correctly summarized. General Transactions-related Audit Objectives

26. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 26 Management Assertions About Classes of Transactions and Events General Transaction- related Audit Objectives Specific Sales Transaction- related Audit Objectives Occurrence Recorded sales are for shipments made to nonfictitious customers Completeness Existing sales transactions are recorded Accuracy Recorded sales are for the amount of goods shipped and are correctly billed and recorded Hillsburg Hardware Co. (Applied to Sales Transactions)

27. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 27 AccuracyPosting and summarization Sales transactions are properly included in the master file and are correctly summarized Classification Sales transactions are properly classified CutoffTimingSales transactions are recorded on the correct dates. General Transaction- related Audit Objectives Management Assertions About Classes of Transactions and Events Specific Sales Transaction- related Audit Objectives Hillsburg Hardware Co. (Applied to Sales Transactions)

28. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 28 Learning Objective 8 Link the eight general balance- related audit objectives to management assertions for account balances.

29. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 29 ExistenceAmounts included exist Completeness Existing amounts are included Accuracy Amounts included are stated at the correct amounts General Balance-related Audit Objectives

30. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 30 Classification Amounts are properly classified Cutoff Transactions are recorded in the proper period Detail tie-in Account balances agree with master file amounts, and with the general ledger General Balance-related Audit Objectives

31. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 31 Realizable value Assets are included at estimated realizable value Rights and obligations Assets must be owned General Balance-related Audit Objectives

32. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 32 Management Assertions About Account Balances General Balance- related Audit Objectives Specific Balance-related Audit Objectives Applied to Inventory Existence All recorded inventory exists at the balance sheet date Completeness All existing inventory has been counted and included in the inventory summary Hillsburg Hardware Co. (Applied to Inventory)

33. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 33 Management Assertions About Account Balances General Balance- related Audit Objectives Valuation and allocation Accuracy Inventory quantities on the client’s perpetual records agree with items physically on hand Prices used to value inventories are materially correct Extensions of price times quantity are correct and details are correctly added Specific Balance-related Audit Objectives Applied to Inventory Hillsburg Hardware Co. (Applied to Inventory)

34. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 34 Management Assertions About Account Balances General Balance- related Audit Objectives Valuation and allocation Classification Cutoff Inventory items are properly classified as to raw materials, work in process, and finished goods Purchase cutoff at year end is proper Sales cutoff at year end is proper Specific Balance-related Audit Objectives Applied to Inventory Hillsburg Hardware Co. (Applied to Inventory)

35. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 35 Management Assertions About Account Balances General Balance- related Audit Objectives Valuation and allocation Detail tie-in Realizable value Total of inventory items agrees with general ledger Inventories have been written down where net realizable value is impaired Specific Balance-related Audit Objectives Applied to Inventory Rights and obligationsRights and obligations The company has title to all inventory items listed Inventories are not pledged as collateral Hillsburg Hardware Co. (Applied to Inventory)

36. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 36 Learning Objective 9 Link the four presentation and disclosure-related audit objectives to management assertions for presentation and disclosure.

37. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 37 Management Assertions About Presentation and Disclosure Specific Presentation and Disclosure-related Audit Objectives Applied to Notes Payable Occurrence and rights and obligations Occurrence and rights and obligations Notes payable as described in the footnotes exist and are obligations of the company Completeness All required disclosures related to notes payable are included in the financial statement footnotes GeneralPresentation- and Disclosure- related Audit Objectives Hillsburg Hardware Co. (Applied to Notes Payable)

38. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 38 Management Assertions About Presentation and Disclosure Specific Presentation and Disclosure-related Audit Objectives Applied to Notes Payable Valuation and allocation Valuation and allocation Footnote disclosures related to notes payable are accurate. Classification and understandability Classification and understandability Notes payable are appropriately classified as to short-term and long-term obligations and related financial statement disclosures are understandable GeneralPresentation- and Disclosure- related Audit Objectives Hillsburg Hardware Co. (Applied to Notes Payable)

39. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 39 Learning Objective 10 Explain the relationship between audit objectives and the accumulation of audit evidence.

40. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 40 How Audit Objectives Are Met The auditor must obtain sufficient appropriate audit evidence to support all management assertions in the financial statements.  An audit process has four specific phases

41. ©2010 Prentice Hall Business Publishing, Auditing 13/e, Arens/Elder/Beasley 6 - 41 Four Phases of a Financial Statement Audit Phase I Plan and design an audit approach Phase II Perform tests of controls and substantive tests of transactions Phase III Perform analytical procedures and tests of details of balances Phase IV Complete the audit and issue an audit report

42. ©2010 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6 - 42 End of Chapter 6