ch05 70 360

Chapter 5:
Audit Responsibilities and

Objectives
5-1
Copyright © 2007 Pearson Education Canada
Chapter 5 Objectives
 Consider the objective of conducting an
audit of financial statements
 Explain the difference between
management and auditor responsibilities
 What is the nature and purpose of the cycle
approach?
5-2
Chapter 5 Objectives (continued)
 Describe management assertions
 Relate management assertions to general
transaction-related and balance-related
audit objectives
 Discuss the audit process and its four
phases
5-3
Objective of an Audit of Financial
Statements
 Are financial statements fairly presented?
 Are financial statements in conformity
with GAAP?
 Expression of an opinion
 The audit is conducted by an independent
auditor
 The audit is conducted in accordance with
GAAS
5-4
Management Responsibilities with
Respect to financial statements
 Adoption of sound accounting policies
 Maintenance of adequate internal controls
 Providing fair representations in the
financial statements
 Remember-management is responsible for

the financial statements and the auditor is
responsible to issue an opinion
5-5
Hillsburg Hardware Illustrates
Management Responsibilities
 Hillsburg Hardware Limited illustrates
management responsibilities:
– P. 144 Management’s Accountability report
– P. 149 Management’s Discussion and Analysis
– P. 143 report on internal control is optional in
Canada
5-6
Auditor Responsibilities with
Respect to Financial Statements
 Expression of an opinion
 Reasonable assurance that material
misstatements are absent:
– Includes errors, fraud and other irregularities
 Plan and perform the audit in accordance
with GAAS
 Independence, confidentiality and
professional conduct
5-7
Types of Misstatements: Some
are Difficult to Detect!
 Error: unintentional misstatement
 Fraud and other irregularities: intentional
– Two types of fraud-management & employee
• Theft of assets, often employee fraud
• Fraudulent financial reporting, often management
fraud
• Computer fraud
• Illegal acts (direct-effect or indirect-effect)
5-8
Provide some examples
 Can you think of any recent financial
scandals talked about in the newspaper?
 What type of errors were presented?
 Was fraud involved?
5-9
The Cycle Approach
 A convenient way to separate transactions
for study and assessment during the audit
 Related types (or classes) of transactions
are part of the same cycle
5-10
Cycles Used in This Text
 Sales and collection
 Acquisition and payment
 Payroll and personnel
 Inventory and warehousing
 Capital acquisition and repayment
5-11
5-12
5-13
What are Management Assertions?
 Implied or expressed representations by

management about classes of transactions
 Are directly related to GAAP
 Part of criteria used by management to
record and disclose information in the F/S
5-14
Management’s Assertions
 Existence
 Occurrence
 Completeness
 Valuation (realizable value)
 Accuracy, measurement or allocation
 Ownership; rights and obligations
 Presentation and disclosure
5-15
Management Assertions Relate to
Audit Objectives
 Financial statements and financial
statement cycles are used to develop
management assertions about accounts
 Each assertion directly relates to an audit
objective (either general or specific)
5-16
Developing General and Specific
Audit Objectives
 Each management objective is related to
either a GENERAL transaction-related
audit objective (for transactions) or a
GENERAL balance-related audit objective
(for general ledger ending balances)
 When applied to a specific transaction or
account, it becomes a SPECIFIC audit
objective
5-17
Management Assertion: Existence
Do assets, obligations (liabilities) and equities exist? Are
they REAL?
 General Balance-Related Audit Objective:

Existence
 Specific Balance-Related Audit Objective
for Inventory: All recorded inventories
exist at the balance sheet date
5-18
Management Assertion: Occurrence
Did included transactions actually happen? Are they
REAL?
 General Transaction-Related Audit

Objective: Occurrence
 Specific Transaction-Related Audit
Objective for Sales: Recorded sales are for
shipments made to nonfictitious customers
5-19
Management Assertion: Completeness
All transactions and amounts that happened are included?
Was anything MISSED or FORGOTTEN?
 General Transaction-Related Audit Objective:
Completeness
 Specific Transaction-Related Audit Objective for
Sales: Existing sales transactions are recorded
Existence
 Specific Balance-Related Audit Objective for
Inventory: All existing inventory has been
counted and included in inventory
5-20
Management Assertion: Valuation
Is the asset at lower of cost or net realizable value? Is the
liability at cost?

Valuation
for Inventory: Inventories have been
written down where net realizable value is
less than book value
5-21
Management Assertion: Accuracy
(Measurement, Part 1)
Were transactions and amounts recorded and processed
properly?
Accuracy
 Specific Transaction-Related Audit Objective
for Sales: Recorded sales are for the amount of
goods shipped and are correctly billed and
recorded
Accuracy
Inventory: Inventory quantities agree with items
physically on hand (See also Table 5-2, p. 125)
5-22
Management Assertion: Classification
Were transactions and amounts recorded in the correct
account?
Classification
Sales: Sales transactions are classified in the
correct account
Classification
Inventory: Inventory items are properly
classified as raw materials, work in process, or
finished goods
5-23
Management Assertion: Allocation
Were transactions and amounts recorded on the right dates
in the correct period?

Timing
Sales: Sales are recorded on the correct dates
 General Balance-Related Audit Objective: Cutoff
Inventory: Purchases at year end are recorded in
the correct period (See also Table 5-2, p. 125)
5-24
Management Assertion: Measurement
Were transactions and amounts updated and aggregated to
the correct account?
 General Transaction-Related Audit Objective: Posting and
Summarization
 Specific Transaction-Related Audit Objective for Sales:
Sales transactions are updated correctly to the customer
master file, and totals posted to the G. L. account correctly.
 General Balance-Related Audit Objective: Detail tie-in
 Specific Balance-Related Audit Objective for Inventory:
Total of inventory items agrees with
G. L.
5-25
Management Assertion: Rights and
Obligations
Rights: Do the assets on hand belong to the company?
Obligations: Were the obligations incurred by the company
(not by someone else)?

Rights and obligations
for Inventory: The company has title to all
inventory items listed. Inventories are not
pledged as collateral.
5-26
Management Assertion: Presentation
and Disclosure
Do the statements include all relevant information in a way
that financial statement users can understand?

Presentation and Disclosure
Inventory: Major categories of inventories and
their bases of valuation are disclosed. (See also
Table 5-2, p. 125)
5-27
Practice problem 5-20 (p. 133)
 Practice matching the specific transaction-
related audit objective to the management
assertion and to the general transaction-
related audit objective
5-28
 This problem provides a series of audit
procedures
 What objectives are these associated with?
 It is important to understand these
objectives, as you may be asked to provide
audit procedures for a particular objective
5-29
The Audit Process
 Prior to accepting or continuing the audit,

assess independence
 Conduct four phases of an audit
 In planning phase, prepare client risk
profile and assess corporate governance
5-30
Four Phases of an Audit
 Phase I - Assess risk and plan the audit
 Phase II - Perform tests of controls
 Phase III - Perform analytical procedures
and test of details of balances
 Phase IV - Complete the audit and issue an
auditor’s report
5-31
Audit Phase I: Risk Assessment and
Audit Planning
 In the context of risks, balance the quantity and
quality of evidence to be collected against costs
of collection
 Obtain knowledge of business, industry, business
environment. Prepare client risk profile.
 Understand internal control and assess control
risk (governance, general controls, cycle
controls)
5-32
 To understand risks, it is important to
understand ‘what could go wrong’
 Here, you are asked to think like a devious
client – how could you overstate net
income?
5-33
Audit Phase II: Perform Tests of
Controls
 Where the auditor plans to rely upon high
quality internal controls, these controls
may need to be tested (certain controls
only need to be tested every three years,
S 5143.41)
 Tests are normally linked to audit
objectives (also called audit assertions)
5-34
Audit Phase III: Perform Analytical
Procedures and Tests of Details of
Balances
 Analytical procedures are both a planning
tool and an actual audit test
 Tests of details of balances are specific
audit procedures designed to test for
monetary misstatements
5-35
Audit Phase IV: Complete and Issue the
Auditor’s Report
 Information collected during the audit
needs to be combined and assessed to
reach an overall conclusion with respect to
the financial statements – are they fairly
stated?
 This assessment requires experience and
professional judgment
5-36
 How do we pull this together?
 Identify problems that could affect the
audit engagement of ABC Electronics Ltd.,
and provide some suggestions on how to
deal with them.
5-37

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Chapter 5:

Audit Responsibilities and

 Remember-management is responsible for

 Implied or expressed representations by

 General Balance-Related Audit Objective:

 General Transaction-Related Audit

 General Balance-Related Audit Objective:

 General Transaction-Related Audit Objective:

 General Balance-Related Audit Objective:

 General Balance-Related Audit Objective:

 Prior to accepting or continuing the audit,

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