Audit Ch 6 - Audit Objectives

Key Takeaway

Assertions lead to Audit Objectives - meaning that once an auditor identifies relevant assertions, the auditors will then identify audit objectives to test those assertions

Rights and Obligations

Balance-related assertion Assets are owned by the company, and liabilities are company obligations

Audit objectives

Closely related to management assertions since one of the main purposes of the audit is to determine whether the management assertions are correct

Timing/Cutoff

Cutoff errors are less likely if transactions are timely prepared. Cutoff errors at year-end is fairly common (which is why when testing for cutoff, you usually pick amounts that exist/occur a week before and after fiscal Y/E)

Confirmation bias (judgment trap)

Definition: Auditor places more weight on information consistent with initial beliefs How to Mitigate: Document any alternative explanations

Availability

Definition: Auditor will value information that is more convenient/acesssible as more relevant than it is (when it comes to evidence collection) How to Mitigate: Consider the objectivity of evidence, Consider why convenience has come to your mind (is the client trying to hide something by making some information/evidence more easy to find than others)

Overconfidence (judgment trap)

Definition: Auditor's overestimate their ability to assess risk or exercise judgment How to Mitigate: Challenge underlying assumptions and Challenge experts and opinions

Anchoring and Adjusting (judgment trap)

Definition: Starting at an initial value and adjust from that point (Ligand Pharmaceuticals case) How to Mitigate: Consider client bias (often times the clients are who gives the auditor the intial anchor), Get outside input

Existence / Occurence

Existence - Balance-related; balances exist Occurence - Transaction-related; transactions occur Existence and occurrence concern whether recorded transactions and balances exist/have actually occurred. Primarily concerned with overstatements - clients are more likely to overstate their assets/transactions - they may claim assets exist that really don't or that transactions/sales occurred that really didn't - Goes from client accounting records to supporting documents (to confirm the existence/occurrence of what is stated on client F/S)

Overall Audit Objective

Express an opinion on the fairness of the financial statements

Posting and Summarization/Detail Tie-In

If trnasactions are correctly posted and summarized, then it is likely that year-end general ledger accounts will agree with supporting detail

Net realizable value (relation of transactions and balance objectives)

NRV is a balance-related valuation issue with no corresponding transaction objetive. Some transaction objectives do affect NRV (i.e., transaction credit approval affects NRV of A/R).

Indirect effect illegal act

No responsibility under auditing standards

An auditor vouches a sample of entries in an account payabale register to the supporting documents. Which assertion would this test most likely support?

Occurence going from accounting records to supporting documents

Relation of Transaction and Balance Objectives

Occurrence: Existence Completeness: Completeness Accuracy: Accuracy Classification: Classification Timing: Cutoff Posting and Summarization: Detail Tie-In None: Net Realizable Value Not applicable: Rights and obligations Presentation and Disclosure: Presentation and Disclosure

PCAOB Management Assertions (Trans/Bal/Disclsoure)

PCAOB standards do not distinguish between transaction and balance assertions

Auditor responsibility to detect errors, fraud, and direct illegal acts:

The auditor should design the audit program to provide reasonable assurance of detecting material errors, fraud and direct-effect illegal acts

Relation of Transaction and Balance Objectives

There is an inverse relationship between the transaction and balance testing for each objective As transaction testing is increased, balance testing, which is usually more costly, can be decreased (since if all the transactions are correct then the balance should be at Y/E) - also transactions can be tested throughout the year (interim period) whereas balances can only be tested at fiscal Y/E

Auditor's Responsibility

To "render an opinon based on our audit" - In rendering the opinion, auditor follows applicable auditing standards - Auditing procedures are designed to provide "reasonable assurance that F/S are free of material misstatement" - Audit should be planned and performed with an attitude of professional skepticism

Why do auditors segment the audit?

To make the audit more manageable and to facilitate the assignment of tasks

Presentation and Disclosure

Transaction and Balance related assertion Items are clearly described, and disclosures are complete in the F/S`

Occurence - Audit Objective

Transaction-related // mgmt assertion of occurence recorded amounts in client F/S represent valid transactions going from accounting records to supporting documents

Accuracy

Transaction-related assertion correct $ amount Price x Quantity

The primary difference between an audit of the B/S and an audit of the I/S is that the audit of the I/S deals with verification of:

Transactions Auditing I/S you will be testing transactions Auditing B/S you will be testing balances

An auditor would most likely analyze inventory turnover rates to obtain evidence concerning management's assertions about:

Valuation or allocation You want a high inventory turnover rate, If client has low turnover, meaning they cannot sell their goods, then you as the auditor may be concerted that the value of the goods being sold is low/weak

Illegal Acts

Violations of laws or government regulations, other than fraud

What is vouching?

Vouching is the act of reviewing documentary evidence to see if it properly supports entries made in the accounting records.

Sources of Material Misstatement in F/S

- Errors: unintentional misstatement of F/S - Fraud - Intentional misstatement

If Auditor Knows of an Illegal Act

- Evaluate effect on F/S, including disclosure - Consider effect on relationship with management - Inform audit committee

Management's Responsibility

- Preparation and integrity (Fairness) of the financial statements, including policies and disclosures - Responsible for effective (adequate) internal controls, and accounting practices.

Common cycles in auditing

- Sales and Collections: A/R and SalesRev: Cash and SalesRev - Acquisitions and payments (Expense cycle) - less risky than sales and collections because you are paying instead of collecting - Payroll: check if the person being paid exists, you can check the hourly rate and the hrs worked - Inventory: existence and valuation - Fixed (capital) asset purchasing: objective, easy to check if they're there (existence)

Misappropriation of assets (defalcation or theft of assets)

- type of fraud - One aspect of the expectation gap is the expectation by clients that the auditor will detect these frauds. Usually, the amounts involved are immaterial. If detected, it is usually by the client

Fraudulent financial reporting / Management Fraud

- type of fraud - difficult to detect because management can often override internal controls, and attempt to conceal the fraud

When a company prepares financial statements, they make the following:

1. Assertions about classes of transactions and events 2. Assertions about account balances at period-end 3. Assertions about presentation and disclosure (of F/S)

Transaction-related objectives

objectives related to classes of trnasactions

Balance-related objectives

objectives related to ending balances in accounts

General vs. Specific Objectives

one or more specific audit objectives or procedures are designed to meet the general audit objectives

Direct effect illegal act

same responsibility as other errors and fraud

Completeness

transaction and balance-related assertion All transactions, balances, and disclosures are included in the client's F/S - checks to see if all balances/transactions that actually exist/occur (should be recorded in client F/S) have actually been recorded or not - Are the F/S complete? - Goes from supporting documents to accounting records - From an audit perspective, concerned with possible understatement since clients may be more inclined to understate liabilities (not include all liabilities in F/S, thus making them incomplete)

Accuracy - Audit Objective

transaction related // mgmt assertion of accuracy prices and quantities are correctly recorded

Classification - Audit Objective

transaction related // mgmt assertion of classification transactions are properly classified into the correct accounts

Completeness - Audit Objective

transaction related // mgmt assertion of completeness all transactions that should be recorded are recorded in the client F/S going from supporting documents to client accounting records

Timing - Audit Objective

transaction related // mgmt assertion of cutoff amounts (transactions) are recorded on the correct dates. - remmber cutoff has to deal with correct period, timing is more specific

Presentation - Audit Objective

transaction related // mgmt assertion of presentation Financial statement disclosures are relevant and understandable

Classification

transaction-related assertion amounts are recorded in the correct accounts and are appropriately presented

Cutoff

transaction-related assertion transactions are recorded in the correct periods

Posting and Summarization - Audit Objective

transaction-related objective // no related mgmt assertion Amounts are properly summarized and recorded in master files Amounts are in the correct subsidiary ledger within a control account ledger ex: making sure that an A/R-Jason is posted to Jason's A/R account and not Chris'. Because if Jason is the person who owes money and you post the A/R amount into A/R-Chris then Chris will get a message saying he owes money when he really doesn't. This differs from classification since classifications just have to deal with that transactions are in the correct accounts. Whereas, Posting and Summarization have to do with transactions being in the proper subsidiary ledgers within an account. - something can be in the correct account but in wrong spot in subsidiary ledger

Completeness - Audiit Objective (Bal)

balance related // mgmt assertion of completeness all amounts that exist are reflected in the F/S going from supporting documents to accounting records of client

Existence - Audit Objective

balance related // mgmt assertion of existence recorded amounts in F/S actually exist going from acccounting records to supporting documents

Accuracy - Audit Objective (bal)

balance related // mgmt assertion of valuation or allocation indiviudal amounts are correct and properly summarized

Presentation - Audit Objective (bal)

balance-related / mgmt assertion of presentation F/S disclsorues are relevant and understanadble

Rights and Obligations - Audit Objective (bal)

balance-related // mgmt assertion of rights and obligations company has title (or ownership) to all items on its balance sheet (that the client is claiming they own)

Classification - Audit Objective (bal)

balance-related // mgmt assertion of valuation or allocation F/S amounts are properly classified. Ex: LT notes v. Current portion of LT note; WIP Inv v. FG Inv; Cash on hand v. investments

Detail Tie-In - Audit Objective (bal)

balance-related // mgmt assertion of valuation or allocation Summary of individual amounts agree with general ledger ex: footing all subsidiary ledgers to see if the sum agrees with the total displayed in the control account A/R-Chris : 500 + A/R-Joe: 200 + A/R-John: 300 = Accounts Receivable balance of $1000 Subsidiary ledgers detail the sum of the control accounts Just because subsidiary ledgers sum to control account does not mean detail is correct. Can have amounts in the wrong sub-ledgers so when you sum everything it's okay, but the sub-ledgers have the wrong amounts.

Cutoff - Audit Objective (bal)

balance-related // mgmt assertion of valuation or allocation amounts are recorded in proper reporting period

Realizable Value - Audit Objective (bal)

balance-related // mgmt assertion of valuation or allocation this objective has to do with asset-type accounts amounts are written down where net realizeable value is impaired

Valuation and allocation

balance-related assertion transactions, amounts, and disclosures are included at the correct amounts

How are audits usually segmented?

based on a cycle approach, with year-end testing organized by balance-sheet account - Efficient since this approach groups accounts that are related through journals - Each cycle generally has a different set of controls

Professional Skepticism

contributes toward reducing the likelihood of an audit failure Consists of two components: 1) Questioning Mindset: a trust but verify mental outlook 2) Critical evaluation of audit evidence - ask probing questions and looking for inconsistencies in client answers

What is an assertion?

fancy word for a representation or statement of fact - something that management is claiming to be true and that can be verified (by the auditor)