Week 6 Unit 5 Audit Responsibilities and Objectives 14.10.2024 (3) PDF

AUDIT RESPONSIBILITIES AND OBJECTIVES LECTURER: SHAUNTAI BURKE DATE: OCTOBER 14, 2024 TIME: 6PM  LESSON OVERVIEW.  LESSON OBJECTIVES STU...

AUDIT RESPONSIBILITIES AND OBJECTIVES LECTURER: SHAUNTAI BURKE DATE: OCTOBER 14, 2024 TIME: 6PM  LESSON OVERVIEW.  LESSON OBJECTIVES STUDENTS AFTER STUDYING THIS UNIT, YOU WILL BE ABLE TO 1. Explain the objectives of conducting an audit of financial statements. 2. Distinguish management’s responsibilities for the preparation of financial statements from the auditor’s responsibilities for verifying those statements 3. Classify accounting information into cycles 4. Identify the benefits of the cycle approach 5. Explain the auditor’s responsibility for discovering material misstatements. 6. Outline the reasons for the auditor obtaining a combination of assurances by auditing classes of transactions and ending balances in accounts. 7. Explain the relationship between audit objectives and the accumulation of audit evidence.  AUDIT TEMPERATURE CHECK BREAKOUT ROOMS 1&2 I. DESCRIBE WHAT THE CYCLE APPROACH TO AUDITING MEANS. II. WHAT ARE THE ADVANTAGES OF DIVIDING THE AUDIT INTO DIFFERENT CYCLES?  AUDIT TEMPERATURE CHECK BREAKOUT ROOMS 3&4 I. DISCUSS THE DIFFERENCES BETWEEN ERRORS, FRAUDS, AND ILLEGAL ACTS. GIVE AN EXAMPLE OF EACH. II. DISCUSS THE ACTIONS AN AUDITOR SHOULD TAKE WHEN AN ILLEGAL ACT IS IDENTIFIED OR SUSPECTED.  OBJECTIVES OF AN AUDIT Companies produce financial statements that provide information about their financial position and performance. This information is used by a wide range of stakeholders in making decisions. Generally, those that own a company, the shareholders, are not those that manage it. Therefore, the owners of these companies take comfort from independent assurance that the financial statements fairly present, in all material respects, the company’s financial position and performance. OBJECTIVES OF CONDUCTING AN AUDIT OF FINANCIAL STATEMENTS The objective of an audit of financial statements is to enable an auditor to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with International Financial Reporting Standards or another identified financial reporting framework. This information is used by a wide range of stakeholders in making decisions. Therefore, the owners of these companies take comfort from independent assurance that the financial statements fairly present, in all material respects, the company’s financial position and performance. OBJECTIVES OF AN AUDIT  MANAGEMENT’S RESPONSIBILITIES FOR PREPARING THE FINANCIAL STATEMENTS They are responsible for adopting sound The annual reports of many public companies accounting policies, maintaining adequate internal include a statement about management’s control, and making fair representations in the responsibilities and relationship with the CPA firm. financial statements rests with management rather than with the auditor. Because they operate the Management’s responsibility for the integrity and business daily, a company’s management knows fairness of the representations (assertions) in the more about the company’s assets, liabilities, and financial statements carries with it the privilege of equity than the auditor. determining which presentations and disclosures it considers necessary. In contrast, the auditor’s knowledge of these matters If management insists on financial statement and internal control is limited to that acquired during disclosure that the auditor finds unacceptable, the the audit. auditor can either issue an adverse or qualified opinion or withdraw from the engagement.  MANAGEMENT’S RESPONSIBILITIES FOR PREPARING THE FINANCIAL STATEMENTS Management is responsible for identifying the financial reporting framework to be used in the preparation and presentation of the financial statements. They should ensure that the appropriate internal controls are in place that can mitigate against the risk of fraud and errors. In the United States, the Sarbanes-Oxley Act has increased management’s responsibility for the financial statements. An example of this is that management must certify the quarterly and annual financial statements submitted to the Securities and Exchange Commission (SEC).  MANAGEMENT’S RESPONSIBILITIES FOR PREPARING THE FINANCIAL STATEMENTS The auditor has a responsibility to However, the auditor's plan and perform the audit to obtain responsibility for the financial reasonable assurance about whether statements he or she has audited is the financial statements are free of confined to the expression of his or material misstatement, whether her opinion on them. You should caused by error or fraud. note that the audit of the financial The auditor's responsibility is to statement does not relieve express an opinion on the financial management or those charged with statements and may make governance of their responsibilities. suggestions about the form or Many companies divide their content of the financial statements or accounting process into transaction draft them, in whole or in part, based cycles so that you can have a clear on information from management appreciation of how information during the performance of the audit. flows. AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS The auditor's responsibility for the financial statements he or she has audited is confined to the expression of his or her opinion on them. You should note that the audit of the financial statement does not relieve management or those charged with governance of their responsibilities.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS The overall objectives of the auditor are: a) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and b) To report on the financial statements, and communicate as required by auditing standards, in accordance with auditor’s findings.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS MATERIAL VERSUS IMMATERIAL When the auditor also MISSTATEMENTS reports on the  Misstatements are usually considered material if the effectiveness of internal combined uncorrected errors and fraud in the financial control over financial statements would likely have changed or influenced the reporting, the auditor is decisions of a reasonable person using the statements. also responsible for  Although it is difficult to quantify a measure of materiality, identifying material auditors are responsible for obtaining reasonable assurance weakness in internal that this materiality threshold has been satisfied. control over financial reporting. AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS REASONABLE ASSURANCE The concept of reasonable, but not Assurance is the measure of the level of absolute, assurance indicates that certainty that the auditor ha obtained at the auditor is not an insurer or the completion of the audit. Auditing guarantor of the correctness of the standards indicate reasonable assurance financial statements. Thus, an audit as high, but not absolute, level of that is conducted in accordance assurance that the financial statements with auditing standards may fail to are free of material misstatements. detect a material misstatement.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS REASONABLE ASSURANCE If auditors were responsible for making certain that all the assertions in the statements were correct, the types and amounts of evidence required and the resulting cost of the audit function would increase to such an extent that audits would not be economically practical. Even, then auditors would be unlikely to uncover all material misstatements in every audit. The auditor’s best defense when material misstatements are not uncovered is to have conducted the audit in accordance with auditing standards. AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS ERROR VERSUS FRAUD Auditing standards distinguish between Two examples of error are a two types of misstatements: errors and mistake in extending price times fraud. Either type of misstatement can quantity on a sales invoice and be material or immaterial. An error is overlooking older raw materials an unintentional misstatement of the in determining the lower of cost financial statements, where as fraud is or market for inventory. intentional.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS ERROR VERSUS FRAUD An example of misappropriation of assets For fraud, there is a is a clerk taking cash at the distinction between time a sale is made and not misappropriation of assets, entering the sale in the often called defalcation or cash register. employee fraud, and An example of fraudulent fraudulent financial financial reporting is the reporting, often called intentional overstatement management fraud. of sales near the balance sheet date to increase reported earnings.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS PROFESSIONAL SKEPTICISM Auditing standards require that an audit be designed to provide reasonable assurance of detecting both material errors and fraud in the financial statements. To accomplish this, the audit must be planned and performed with an attitude of professional scepticism in all aspects of the engagement. Professional scepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. Auditors should not assume that management is dishonest, but the possibility of dishonesty must be considered. At the same time, auditors also should not assume that management is unquestionably honest.  AUDITOR’S RESPONSIBILITIES FOR DETECTING MATERIAL ERRORS 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.  AUDITOR’S RESPONSIBILITIES FOR DETECTING MATERIAL FRAUD Auditing standards make no distinction between the auditor’s responsibilities for searching for errors or fraud. In either case, the auditor must obtain reasonable assurance about whether the statements are free of material misstatements. The standards also recognize that fraud is often more difficult to detect because management or the employees perpetrating the fraud attempt to conceal the fraud. Still, the difficulty of detection does not change the auditor’s responsibility to properly plan and perform the audit to detect material misstatements, whether caused by error or fraud.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS Auditor’s responsibilities for discovering illegal acts Illegal acts are defined as violations of laws or government regulations other than fraud. Two examples of illegal acts are a violation of federal tax laws and a violation of the federal environmental protection laws. Direct-effect illegal acts Certain violations of laws and regulations have a direct financial effect on specific account balances in the financial statements. For eg., A violation of federal tax laws directly affects income tax expense and income taxes payable. The auditors responsibility for these direct- effect illegal acts is the same as for errors and fraud.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS On each audit, therefore, the auditor normally evaluates whether or not there is evidence available to indicate material violations of federal or state tax laws. To do this evaluation, the auditor might hold discussions with client personnel and examine reports issued by the internal revenue service after completion of an examination of the client’s tax return.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS Indirect-effect illegal acts Most illegal acts affect the financial statements only indirectly. For example, if the company violates environmental protection laws, financial statements are affected only if there is a fine or sanction. Potential material fines and sanctions indirectly affect financial statements by creating the need to disclose a contingent liability for the potential amount that might ultimately be paid. This is called an indirect-effect illegal act. Other examples of illegal acts that are likely to have only an indirect effect are violations of insider securities trading regulations, civil right laws, and federal employee safety requirements.  AUDITOR’S RESPONSIBILITIES FOR VERIFYING FINANCIAL STATEMENTS Auditing standards state that the auditor provides no assurance that indirect-effect illegal acts will be detected. Auditors lack legal expertise, and the frequent indirect relationship between illegal acts and the financial statements makes it impractical for auditors to assume responsibility for discovering those illegal acts. Auditors have three levels of responsibility for finding and reporting illegal acts: Evidence accumulation when there is no reason to believe indirect-effect illegal acts exist Evidence accumulation and other actions when there is reason to believe direct-or- indirect-illegal acts may exist Actions when the auditor knows of an illegal act  CLASSIFICATION OF ACCOUNTING INFORMATION INTO CYCLES The auditors need to obtain an understanding of the control activities of the entity that they are reviewing. This process involves mapping the significant financial statement accounts to the related transaction cycles. Control activities are established according to transaction cycles rather than to financial statement accounts, for example, an entity may not have established controls over the existence of cash collection but may have implemented controls over the sales and collection cycle that affect revenue, accounts receivable and cash accounts.  FINANCIAL STATEMENT CYCLES 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  FINANCIAL STATEMENT CYCLES The logic of using the cycle approach is that it ties to the way transactions are recorded in journals and summarized in the general ledger and financial statements. To the extent that it is practical, the cycle approach combines transactions recorded in different journals with the general ledger balances that result from those transactions.  FINANCIAL STATEMENT CYCLES RELATIONSHIPS AMONG CYCLES A company begins by obtaining capital, usually in the form of cash. In a manufacturing company, cash is used to acquire raw materials, fixed assets, and related goods and services to produce inventory (acquisition and payment cycle). Cash is also used to acquire labour for the same reason (payroll and personnel cycle). Acquisition and payment and payroll and personnel are similar in nature, but the functions are sufficiently different to justify separate cycles. The combined results of these two cycles is inventory (inventory and warehousing cycle).  FINANCIAL STATEMENT CYCLES At subsequent point, the inventory is sold and billings and collections result (sales and collection cycle). The cash generated is used to pay dividends and interest or finance capital expansion and to start the cycles again. The cycles interrelate in much the same way in a service company, where there will be billings and collections, although there will be no inventory. Transaction cycles are an important way to organize audits. For the most part, auditors treat each cycle separately during the audit. Although auditors need to consider the interrelationships between cycles, they typically treat cycles independently to the extent practical to manage complex audits effectively.  SETTING AUDIT OBJECTIVES Auditors conduct financial statement audits using the cycle approach by performing audit tests of the transactions making up ending balances and also by performing audit tests of the account balances and related disclosures. In figure 6-6 assume that the beginning balance of $17,521 was audited in the prior year and is therefore considered fairly stated. If the auditor could be completely sure that each of the four classes of transactions is correctly stated, the auditor could also be sure that the ending balance of $20, 197 is correctly stated.  SETTING AUDIT OBJECTIVES  But it is almost always impractical for  For any given class of transactions, several audit the auditor to obtain complete objectives must be met before the auditor can assurance about the correctness of each conclude that the transactions are properly recorded. These are called transaction-related audit class of transactions, resulting in less objectives in the remainder of this book. For than complete assurance about the example, there are specific sales transaction-related ending balance in accounts receivable. audit objectives and specific sales returns and  Auditors have found that, generally, the allowances transaction-related audit objectives. most efficient and effective way to conduct audits is to obtain some  Similarly, several audit objectives must be met for combination of assurance for each class each account balance. These are called balance- of transactions and for the ending related audit objectives. For example, there are specific accounts receivable balance-related audit balance in the related accounts. objectives and specific accounts payable balance- related audit objectives.  SETTING AUDIT OBJECTIVES The third category of audit objectives relates to the presentation and disclosure of information in the financial statements. These are called presentation and disclosure-related audit objectives. For example, there are specific presentation and disclosure-related audit objectives for accounts receivable and notes payable.  HOW AUDIT OBJECTIVES ARE MET  The 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.  The auditor must decide the appropriate audit objectives and the evidence to accumulate to meet those objectives on every audit. To do this, auditors follow an audit process, which is a well-defined methodology for organizing an audit to ensure that the evidence gathered is both sufficient and appropriate and that all required audit objectives are both specified and met.  HOW AUDIT OBJECTIVES ARE MET If the client is an accelerated filer public company, the auditor must also plan to meet the objectives associated with reporting on the effectiveness of internal control over financial reporting. PCAOB auditing standard 5 requires that the audit of effectiveness of internal control be integrated with the audit of financial statements.  SUMMARY The objective of an audit is for the auditor to provide an opinion on whether or not the financial statements are fairly presented. The auditor has the responsibility to notify users through the auditor’s report. Management has the responsibility for the integrity and fairness of the representations of the financial statements. There are different ways of segmenting an audit. One way to divide an audit is called the cycle approach. This approach keeps closely related types (or classes) of transactions and account balances in the same segment. The cycle approach ties to the way transactions are recorded in journals and summarized in the general ledger and financial statements.  REFERENCE FUNDAMENTAL OF FINANCIAL ACCOUNTING – PHILLIPS, LIBBY , LIBBY ISSUE 8. GLOBAL PERSPECTIVES AND INSIGHTS INTERNAL AUDIT AND EXTERNAL AUDIT DISTINCTIVE ROLES IN ORGANIZATIONAL GOVERNANCE HTTPS://GLOBAL.THEIIA.ORG/KNOWLEDGE/PUBLIC%20DOCUMENTS/GPI-DISTI NCTIVE-ROLES-IN-ORGANIZATIONAL-GOVERNANCE.PDF