RR Chapter 06

Learning Objective 1
Audit Responsibilities Explain the objective of

and Objectives conducting an audit of
financial statements and
Chapter 6 an audit of internal controls.
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6-1 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6-2
Objective of Conducting an Steps to Develop Audit

Audit of Financial Statements Objectives
The objective of the ordinary audit of financial 1. Understand objectives and
statements is the expression of an opinion of responsibilities for the audit.
the fairness with which they present fairly, in
all respects, financial position, result of 2. Divide financial statements into cycles.
operations, and its cash flows in
conformity with GAAP. 3. Know management assertions about
accounts.
Steps to Develop Audit

Objectives
4. Know general audit objectives for Distinguish managements
classes of transactions and accounts.
responsibility for the financial
5. Know specific audit objectives for statements and internal control
classes of transactions and accounts.
from the auditors responsibility
for verifying the financial
statements and effectiveness
of internal control.
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-1

Managements Managements
Responsibilities Responsibilities
Management is responsible for the financial The Sarbanes-Oxley Act provides for criminal
statements and for internal control. penalties for anyone who knowingly falsely
certifies the statements.
The Sarbanes-Oxley Act increases managements
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.
Learning Objective 3 Auditors Responsibilities
Explain the auditors Material versus immaterial misstatements
responsibility for discovering Reasonable assurance

material misstatements. Errors versus fraud
Professional skepticism
Fraud resulting from fraudulent financial

reporting versus misappropriation of assets
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6-9 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6 - 10
Auditors Responsibilities for Auditors Responsibilities for

Discovering Illegal Acts Discovering Illegal Acts
Direct-effect illegal acts Evidence accumulation and other actions
when there is reason to believe direct- or
Indirect-effect illegal acts indirect-effect illegal acts may exist
Evidence accumulation when there is no reason Actions when the auditor knows of an illegal act
to believe indirect-effect illegal act exists
2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6 - 11 2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 6 - 12

Learning Objective 4 Financial Statements Cycles
Classify transactions and account Audits are performed by dividing the financial
statements into smaller segments or components.
balances into financial statement
cycles and identify benefits of a
cycle approach to segmenting
the audit.
Transaction Flow Example Transaction Flow Example

Ledgers, Ledgers,
Transactions Journals Trial Balance, Transactions Journals Trial Balance,
and Financial Cash and Financial
Sales Statements Cash Statements
Sales disbursements
journal disbursements
General ledger journal General ledger
and subsidiary and subsidiary
records records
Payroll
Cash Cash receipts Payroll
services and
receipts journal journal
General ledger disbursements General ledger
trial balance trial balance
Acquisition Allocation
Acquisitions Financial General Financial
of goods and
journal statements journal statements
and services adjustments
Relationships Among
Transaction Cycles
General
cash Describe why the auditor obtains
Capital acquisition
a combination of assurance by
and repayment cycle
auditing classes of transactions
Sales and Acquisition Payroll and and ending balances in accounts,
collection and payment personnel
cycle cycle cycle
including presentation and
Inventory and disclosure.
warehousing
cycle

Balance and Transactions
Affecting Balances Example
Accounts Receivable (in thousands)
Distinguish among the three
Beginning balance $ 17,521
categories of management
Sales $144,328 $137,087 Cash receipts
assertions about financial
Sales returns
$ 1,242 and allowances information.
Charge-off of
$ 3,323 uncollectible
accounts
Ending balance $ 20,197

Management Assertions for

Management Assertions
Each Category of Assertions
Assertions About Classes Assertions About Assertions About
1. Assertions about classes of transactions and of Transactions and Events Account Balances Presentation and Disclosure
events for the period under audit Occurrence Existence Occurrence and rights
and obligations
Completeness Completeness Completeness
2. Assertions about account balances a period end Accuracy Valuation and Accuracy and
allocation valuation
Classification Classification and
3. Assertions about presentation and disclosure understandability
Cutoff
Rights and
obligations
General Transactions-related
Learning Objective 7 Audit Objectives
Link the six general transaction- Occurrence

Recorded transactions
exist
related audit objectives to
management assertions Existing transactions
Completeness
are recorded
for classes of transaction.
Recorded transactions
Accuracy are stated at the
correct amounts

General Transactions-related Management Assertions and
Audit Objectives Transaction-related Audit Objectives
Hillsburg Hardware Company:
As Applied to Sales Transactions
Transactions are included
Posting and Management Assertions General Transaction- Specific Sales Transaction-
in the master files and About Classes of related Audit related Audit Objectives
summarization Transactions and Events Objectives
are correctly summarized.
Occurrence Occurrence Recorded sales are for
shipments made to
nonfictitious customers
Transactions are properly
Classification
classified. Completeness Completeness Existing sales
transactions are recorded
Accuracy Accuracy Recorded sales are for
Transactions are recorded the amount of goods
Timing shipped and are correctly
on the correct dates.
billed and recorded
Management Assertions and

Transaction-related Audit Objectives Learning Objective 8
As Applied to Sales Transactions
Management Assertions General Transaction- Specific Sales Transaction-
Link the eight general balance-
About Classes of related Audit related Audit Objectives
Transactions and Events Objectives related audit objectives to
Accuracy Posting and Sales transactions are
summarization properly included in the management assertions
master file and are
correctly summarized for account balances.
Classification Classification Sales transactions are
properly classified
Cutoff Timing Sales transactions are
recorded on the correct
dates.
General Balance-related General Balance-related

Audit Objectives Audit Objectives
Amounts are properly
Existence Amounts included exist Classification
classified
Existing amounts are Transactions are recorded

Completeness Cutoff
included in the proper period
Amounts included are Account balances agree

Accuracy stated at the correct Detail tie-in with master file amounts,
amounts and with the general ledger

General Balance-related Management Assertions and
Audit Objectives Transaction-related Audit Objectives
Realizable Assets are included at As Applied to Inventory
value estimated realizable value Management Assertions General Balance- Specific Balance-related Audit
About Account Balances related Audit Objectives Applied to Inventory
Objectives
Rights and Existence Existence All recorded inventory exists
Assets must be owned
obligations at the balance sheet date
Completeness Completeness All existing inventory has
been counted and included
in the inventory summary
Management Assertions and Management Assertions and

Transaction-related Audit Objectives Transaction-related Audit Objectives
Hillsburg Hardware Company: Hillsburg Hardware Company:
As Applied to Inventory As Applied to Inventory
Management Assertions General Balance- Specific Balance-related Audit Management Assertions General Balance- Specific Balance-related Audit
About Account Balances related Audit Objectives Applied to Inventory About Account Balances related Audit Objectives Applied to Inventory
Objectives Objectives
Valuation and Accuracy Inventory quantities on the Valuation and Classification Inventory items are properly
allocation clients perpetual records allocation classified as to raw
agree with items physically materials, work in process,
on hand and finished goods
Prices used to value Cutoff Purchase cutoff at year end
inventories are materially is proper
correct Sales cutoff at year end is
Extensions of price times proper
quantity are correct and
details are correctly added
Management Assertions and

Transaction-related Audit Objectives Learning Objective 9
As Applied to Inventory Link the four presentation and
Management Assertions General Balance- Specific Balance-related Audit
About Account Balances related Audit Objectives Applied to Inventory disclosure-related audit objectives
Objectives
Valuation and Detail tie-in Total of inventory items to management assertions for
allocation agrees with general ledger
Realizable Inventories have been written presentation and disclosure.
value down where net realizable
value is impaired
Rights and obligations Rights and The company has title to all
obligations inventory items listed
Inventories are not pledged
as collateral

Management Assertions and Presentation Management Assertions and Presentation
and Disclosure-related Audit Objectives and Disclosure-related Audit Objectives
Hillsburg Hardware Company: Hillsburg Hardware Company:
As Applied to Notes Payable As Applied to Notes Payable
Management General Specific Presentation and Management General Specific Presentation and
Assertions About Presentation- Disclosure-related Audit Objectives Assertions About Presentation- Disclosure-related Audit Objectives
Presentation and and Disclosure- Applied to Notes Payable Presentation and and Disclosure- Applied to Notes Payable
Disclosure related Audit Disclosure related Audit
Objectives Objectives
Occurrence Occurrence Notes payable as described in the Valuation and Valuation and Footnote disclosures related to
and rights and and rights and footnotes exist and are allocation allocation notes payable are accurate.
obligations obligations obligations of the company
Classification Classification Notes payable are appropriately
Completeness Completeness All required disclosures related and and classified as to short-term and
to notes payable are included in understandability understandability long-term obligations and
the financial statement footnotes related financial statement
disclosures are understandable
Learning Objective 10 How Audit Objectives Are Met
Explain the relationship between The auditor must obtain sufficient appropriate
audit evidence to support all management
audit objectives and the assertions in the financial statements.
accumulation of audit evidence.
An audit process has four specific phases
Four Phases of a Financial

Statement Audit
Plan and design

Perform analytical
procedures and
End of Chapter 6
Phase I an audit approach Phase III tests of details
of balances
Perform tests of
Complete the
controls and
Phase II substantive tests Phase IV audit and issue
an audit report
of transactions

RR Chapter 06

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Learning Objective 1

Audit Responsibilities Explain the objective of

Objective of Conducting an Steps to Develop Audit

Steps to Develop Audit

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-1

It requires the CEO and the CFO of public

Learning Objective 3 Auditors Responsibilities

Explain the auditors Material versus immaterial misstatements

responsibility for discovering Reasonable assurance

Fraud resulting from fraudulent financial

Auditors Responsibilities for Auditors Responsibilities for

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-2

Transaction Flow Example Transaction Flow Example

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-3

Ending balance $ 20,197

Management Assertions for

Link the six general transaction- Occurrence

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-4

Management Assertions and

General Balance-related General Balance-related

Existing amounts are Transactions are recorded

Amounts included are Account balances agree

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-5

Management Assertions and Management Assertions and

Management Assertions and

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-6

Learning Objective 10 How Audit Objectives Are Met

Four Phases of a Financial

Plan and design

2008 Prentice Hall Business Publishing, Auditing 12/e, Arens/Beasley/Elder 1-7

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