Audit Reports 6

Chapter 6

Audit Responsibilities and Objectives

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Concept Checks

P. 176

1. It is management’s responsibility to adopt sound accounting policies, maintain adequate internal control, and make fair representations in the financial statements. The auditor’s responsibility is to conduct an audit of the financial statements in accordance with auditing standards and report the findings of the audit in the auditor’s report.

2. Auditing standards require that the audit be planned and performed with an attitude of professional skepticism in all aspects of the engagement, recognizing the possibility that a material misstatement could exist regardless of the auditor’s prior experience with the integrity and honesty of client management and those charged with governance. Professional skepticism consists of two primary components: a questioning mind and a critical assessment of audit evidence. A questioning mind means the auditor approaches the audit with a “trust but verify” mental outlook. A critical assessment of audit evidence includes asking probing questions and paying attention to inconsistencies.

P. 192

1. The cycle approach is a method of dividing the audit such that closely related types of transactions and account balances are included in the same cycle. For example, sales, sales returns, and cash receipts transactions and the accounts receivable balance are all a part of the sales and collection cycle. The advantages of dividing the audit into different cycles are to divide the audit into more manageable parts, to assign tasks to different members of the audit team, and to keep closely related parts of the audit together.

2. Management assertions are implied or expressed representations by management about classes of transactions and the related accounts and disclosures in the financial statements. These assertions are part of the criteria management uses to record and disclose accounting information in financial statements.

The PCAOB describes five categories of management assertions:

1. Existence or occurrence?Assets or liabilities of the public company exist at a given date, and recorded transactions have occurred during the period.

2. Completeness?All transactions and accounts that should be presented

in the financial statements are so included.

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Concept Check, P. 192 (continued)

3. Valuation or allocation?Assets, liability, equity, revenue, and expense components have been included in the financial statements at appropriate amounts.

4. Rights and obligations?The public company holds or controls rights to the assets, and liabilities are obligations of the company at a given date. 5. Presentation and disclosure?The components of the financial statements are properly classified, described, and disclosed.

The PCAOB provides for one set of assertions that apply to all financial statement information. These assertions are similar to the assertions in international and AICPA auditing standards, except that international and AICPA standards further divide management assertions into three categories:

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

? Review Questions

6-1 The objective of the audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which the financial statements present financial position, results of operations, and cash flows in conformity with applicable accounting standards. The auditor meets that objective by accumulating sufficient appropriate evidence to determine whether management’s assertions regarding the financial statements are fairly stated.

6-2 An error is an unintentional misstatement of the financial statements. Fraud represents an intentional misstatement. The auditor is responsible for obtaining reasonable assurance that material misstatements in the financial statements are detected, whether those misstatements are due to fraud or error. An audit must be designed to provide reasonable assurance of detecting material misstatements in the financial statements. Further, the audit must be planned and performed with an attitude of professional skepticism in all aspects of the engagement. Because there is an attempt at concealment of fraud, material misstatements due to fraud are usually more difficult to uncover than errors. The auditor’s best defense when material misstatements (either errors or fraud) are not uncovered in the audit is that the audit was conducted in accordance with auditing standards.

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6-3 Auditors spend a great portion of their time planning and performing audits to detect unintentional mistakes made by management and employees. Auditors find a variety of errors resulting from such things as mistakes in calculations, omissions, misunderstanding and misapplication of accounting standards, and incorrect summarizations and descriptions. The auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards recognize that fraud is often more difficult to detect because management or the employees perpetrating the fraud attempt to conceal the fraud, similar to the Satyam case. However, difficulty of detection does not change the auditor’s responsibility to properly plan and perform the audit to detect material misstatements, whether caused by fraud or error. 6-4 CHARACTERISTIC 1. Management’s characteristics and influence over the control environment. AUDIT STEPS ? Investigate the past history of the firm and its management. ? Discuss the possibility of fraudulent financial reporting with previous auditor and company legal counsel after obtaining permission to do so from management. ? Research current status of industry 2. Industry conditions. and compare industry financial ratios to the company’s ratios. Investigate any unusual differences. ? Read the AICPA Industry Audit Risk Alert for the company’s industry, if available. Consider the impact of specific risks that are identified on the conduct of the audit. 3. Operating characteristics and financial stability. ? Perform analytical procedures to evaluate the possibility of business failure. ? Investigate whether material transactions occur close to year-end.

6-5 The auditor should obtain sufficient appropriate evidence regarding material amounts and disclosures that are directly affected by laws and regulations. For example, the auditor should perform tests to identify if there have been any material violations of federal or state tax laws. The auditor should inquire of management and inspect correspondence with relevant licensing and regulatory agencies to identify instances of noncompliance with other laws and regulations that may have a material effect on the financial statements. During the audit,

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