AUDIT OF

FINANCIAL
STATEMENT
Aida Hazlin
AUD589
Topics to be covered
• Management Assertions
• Overview of FS cycle
• Types of FS cycles
• Audit procedures for FS cycle

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Objectives of Financial Statement Audit
• To enable the auditor to express an opinion whether the
financial statements are prepared, in all material respects, in
accordance with an identified reporting framework
• To enable auditor to express an opinion on the truth and
fairness of the financial statements

3
Management’s Responsibilities
• Adopting sound accounting policies
• Maintaining adequate internal control
• Making fair representations in the financial statements
• Auditors are not taking over management’s responsibilities

4
Auditor’s Responsibilities
• Material vs. immaterial misstatement
• Reasonable assurance
• Error vs. fraud
• Professional skepticism
• Compliance vs. non-compliance

5
Cycles of Financial Statements
• Sales and collection cycle
• Acquisition and payment cycle
• Payroll and personnel cycle
• Inventory and warehousing cycle
• Capital acquisition and repayment cycle

6
Management Assertions
• Management is responsible for ensuring that the financial
statements give true and fair view in accordance with the
applicable financial reporting framework
• Mgmt makes various explicit and implicit assertions about the
elements of those financial statements
• These assertions are management’s representation relating to the
recognition and measurement of the various items and components
in the financial statements

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 Management Assertions
ISA 500 – Classifies assertions into seven categories:
1. Existence E
2. Occurrence O
3. Rights and obligations R
4. Completeness C
5. Valuation or allocation V
6. Measurement M
7. Presentation and disclosure P

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Management Assertions
• Existence: the assets and liabilities exist at a given date
– E.g. management asserts that inventory shown on the balance sheet physically exists and
is available for sale

• Rights and obligations: the assets are rights of the entity, and the liabilities are
its obligation
– E.g. management asserts that the entity has legal rights of ownership to the inventory
shown in the balance sheet
– E.g. amount capitalizes for leases reflect assertions that the entity has rights to leased
property and that the corresponding lease liability represents an obligation of the entity

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 Management Assertions
• Occurrence: a transaction or event has taken place
– E.g. management asserts that revenues reported in the income statement represent
valid sales that occurred during the period

• Completeness: the accounts and transactions that should be

included are included; thus the financial statements are
complete
– E.g. management asserts that inventory represents all items on hand at the balance
sheet date
– Management also implicitly asserts that the amounts payable on the balance sheet
includes all such liabilities as of the balance sheet date

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 Management Assertions
• Valuation: assets and liabilities are recorded at appropriate carrying date
– E.g. management asserts that inventory carried at the lowest cost or market value on the balance sheet

• Measurement: a transaction is recorded at the proper amount and revenue or expenses is

allocated to the proper accounting period
– E.g. management asserts that the cost of property, plant and equipment is systematically allocated to
appropriate accounting period by recognising depreciation charge

• Presentation and disclosure: amounts shown in the financial statements are properly
presented and disclosed
– E.g. management asserts that the portion of long term debt shown as current liability will mature in the
current year.
– E.g. management asserts through notes disclosure, that all major restrictions on the entity resulting
from debt convenants are disclosed
11AUD
390/YMI
Audit Objectives
• In obtaining evidence to support the assertions contained in the financial
statements, the auditor develops specific audit objectives that relate to each
management assertions
• Once the auditor has sufficient evidence that the set of audit objectives is met,
he has reasonable assurance that the financial statements are fairly presented

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Setting Audit Objectives
• Specific/general transaction- related audit objectives
– E.g. sales, sales return

• Specific/general balance-related audit objectives

– E.g. account receivables, account payable

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Transaction-related Audit Objectives
• Existence
• Completeness
• Accuracy
• Classification
• Timing
• Posting and summarization
Balance-related Audit Objectives
• Existence
• Completeness
• Accuracy
• Classification
• Cutoff
• Detail tie-in
• Realizable value
• Rights and obligations
• Presentation and disclosure
How Audit Objectives Are Met
• Plan and design an audit approach
– Obtain knowledge of the client’s business strategies and processes, and assess risks
involved
– Understand internal control and assess control risk

• Perform tests of controls and substantive test of transactions

• Perform analytical procedures and tests of details of balances

• Complete the audit and issue an audit report

• 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
Four Phases of F/S Audit
Phase 1: Plan and design an audit
approach

Phase 2: Perform tests of controls and

substantive test of transactions

Phase 3: Perform analytical procedures

and test of details of balances

Phase 4: Complete the audit and issue

an audit report
How Audit Objectives Are Met
• Test of controls – auditor will test the effectiveness of the
controls.
(eg: client’s internal controls require the verification by an
independent clerk of all unit selling prices on sales before sales
invoices are mailed to customers)

• Subtantive tests of transactions – auditor evaluate the

client’s recording of transactions by verifying the
monetary amount of transactions.
(eg: auditor to compare the unit selling price on a duplicate sales invoice with
the approved price list as a test of the accuracy objectives for sales transactions)
How Audit Objectives Are Met
• Analytical procedures – use comparisons and relationships to
assess whether account balances or other data appear reasonable.
(eg: an analytical procedure that would provide some assurance for the
accuracy objective for both sales transactions and account receivables is to
examine sales transactions in the sales journal for unusually large amounts
and to compare total monthly sales with prior years. )

• Test of detail balances – test for monetary misstatements in the

balances in the financial statements.
(eg: related to the accuracy objective for accounts receivable is direct written
communication with the client’s customers. This test is essential to the
conduct of the audit because most of the evidence is obtained from a source
independent of the client and therefore considered to be of high quality)

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Relationships among Management’s Assertion, Audit Objectives,
Audit Procedures, and Audit Evidence

Management’s assertions are contained in the financial statements

Auditor develops audit objectives based on management’s assertions

Audit procedures are conducted to test the audit objectives

Audit Evidence is developed to support management’s assertions

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End of topic