Objective of Conducting an Audit of Financial Statements
that the auditor finds unacceptable, the
- The purpose of an audit is to provide financial
statement users with an opinion by the auditor on
whether the financial statements are presented
fairly, in all material respects, in accordance with
the appliable financial accounting framework,
which enhances the degree of confidence that
intended users can place in the financial
statements.
- If the auditor believes that the statements are not
fairly presented or is unable to reach a conclusion
because of insufficient evidence, the auditor has
the responsibility of notifying user through the
auditor’s report.
Steps to Develop Audit Objectives
1. Understand objectives and responsibilities for the
audit.
2. Divide financial statements into cycles.
3. Know management assertions about financial
statements.
4. Know general audit objectives for class of
transactions, accounts, and disclosures.
5. Know specific audit objectives for classes of
transactions, accounts, and disclosures.
Management’s Responsibilities
- The responsibility for adopting sound accounting
policies, maintaining adequate internal control,
and making fair representation in the financial
statements rests with management rather that
with the auditor.
o Management knows more about the
company’s transactions and related
assets, liabilities, and equity.
o The annual reports of many public
companies include a statement about
management’s responsibilities and
relationship with the CPA firm.
o Management’s responsibility for integrity
and fairness of the representations
(assertions) in the FS carries with it the
privilege of determining which
presentations and disclosures it considers
necessary.
o If management insists on FS disclosures
auditor can either issue an adverse or
qualified opinion or withdraw from the
engagement.
o Sarbanes-Oxley Act requires CEO and
CFO of public companies to certify
quarterly and annual FS.
Auditor’s Responsibilities
The overall objectives of the auditor, in conducting an
audit of financial statements are to:
a. 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 on whether the financial statements are
presented fairly, in all material respects, in
accordance with an applicable financial reporting
framework.
b. Report on the FS, and communicate as required
by auditing standards, in accordance with the
auditor’s findings.
Material vs Immaterial Misstatements
- Misstatements are usually considered material if
the combined uncorrected errors and fraud in the
FS would likely have changed or influenced the
decisions of a reasonable person using the
statements.
Reasonable Assurance
- Assurance is a measure of the level of certainty
that the auditor has obtained at the completion of
the audit.
- High but not absolute level of assurance that the
FS are free of material misstatements.
- Concept indicates that the auditor is not an
insurer or guarantor of the correctness of the FS.
Errors vs Fraud
- Either type of misstatement can be material or
immaterial
o Error – unintentional misstatement
o Fraud – intentional misstatement
 ▪ Misappropriation of Assets came to the auditor’s attention during the course
(Employee Fraud) of the audit.
• Taking of cash
Professional Skepticism
▪ Fraudulent Financial Reporting
(Management Fraud) Aspects of Professional Skepticism
• Intentional
1. Questioning minds
overstatement of sales
a. Maintaining a questioning mind helps
Mistakes auditors offset the natural bias to want to
trust the client
1. Calculations
b. Trust but verify mental outlook
2. Omissions
2. Critical assessment of the audit evidence
3. Misunderstanding
a. Asking probing questions
4. Misapplication of accounting standards
b. Paying attention to inconsistencies
5. Incorrect summarizations and descriptions
6 Characteristics of Professional Skepticism
Laws and Regulations with Direct Effect on the FS
1. Questioning mindset
1. Tax
2. Suspension of judgment
2. Pension Laws
3. Search for knowledge
Laws and Regulations w/o Direct Effect on the FS 4. Interpersonal understanding
5. Autonomy
1. Complying with the terms of an operating license
6. Self-esteem
2. Federal employee safety requirements
3. Environmental regulations Professional Judgment

Audit Procedures When Noncompliance is Identified or Elements

Suspected
1. Identify and define the issue.
1. Obtain an understanding of the nature and 2. Gather the facts and information and identify the
circumstances of the act. relevant literature.
2. Additional information should be obtained to 3. Perform the analysis and identify potential
evaluate the possible effects on the FS. alternatives.
3. Discuss the matter with management at a level 4. Make the decision.
above those involved with the suspected 5. Review and complete the documentation and
noncompliance, and when appropriate, those rationale for the conclusion.
charged with government.
Judgment Tendency Strategy to Avoid
4. If management or those charged with governance
Confirmation: put more Make the opposing
are unable to provide sufficient evidence, and the weight on information case and consider
auditor believes the effect of the noncompliance consistent with initial alternative explanations
may be material, the auditor should consider the beliefs
need to obtain legal advice. Overconfidence: Challenge opinions and
overestimate one’s own experts
Reporting of Identified or Suspected Noncompliance
abilities to perform tasks Challenge underlying
- Unless the matters involved are inconsequential, or make accurate assumptions
the auditor should communicate with those assessments
charged with governance matters involving Anchoring: make Solicit input from others
noncompliance with laws and regulations that assessments by starting
to form an initial value
 and then adjusting Management Assertions
insufficiently away from
that initial value - Implied or expressed representations by
Availability: tendency to Consider why management about classes of transaction and the
consider information something comes to related accounts and disclosures in the FS.
that is easily retrievable mind. - Most of the time, implied.
or accessible as being Obtain and consider - Directly related to the financial reporting
more likely or more objective data. framework used by the company (usually GAAP or
relevant Consult with others and IFRS), as they are part of the criteria that
make the opposing case management uses to record and disclose
accounting information in financial statements.
Financial Statement Cycles 2 Categories of Management Assertions
- Audits are performed by dividing the FS into 1. Assertions about classes of transactions and
smaller segments or components. events and related disclosures for the period
- Makes the audit more manageable. under audit
Different ways of segmenting an audit 2. Assertions about account balances and related
disclosures at period end
1. Treat every account balance on the statements as
a separate segment (inefficient) PCAOB Auditing International Auditing Standards and
Standards AICPA Auditing Standards
2. Keep closely related types (or classes) of
Assertions
transactions and account balances in the same
Assert about Classes of Account
segment. (Cycle approach)
Transactions, Transactions and Balances and
Cycles Balances, and Events and Related
Presentation and Related Disclosures
1. Sales and collection cycle Disclosure Disclosures
2. Acquisition and payment cycle Existence or Occurrence Existence
3. Payroll and personnel cycle occurrence
4. Inventory and warehousing cycle Completeness Completeness Completeness
5. Capital acquisition and repayment cycle Valuation or Accuracy Accuracy,
Allocation Classification valuation, and
Setting Audit Objectives Cutoff allocation
Auditors conduct FS audits using the cycle approach by Classification
performing audit tests of the transactions making up the Rights and Rights and
Obligations Obligations
ending balances and also by performing audit tests of the
Presentation and Presentation Presentation
account balances and related disclosures
Disclosure
- Transaction-related Audit Objectives – for any
given class of transactions and related
Relevant Assertions – have a meaningful bearing on
disclosures, several audit objectives must be met
whether the account is fairly stated and are used to
before the auditor can conclude that the
assess the risk of material misstatement and the design
transactions are properly recorded and
and performance of audit procedures.
appropriately disclosed.
- Balance-related Audit Objectives – several audit
objectives must be met for each account balance
and related disclosures.
Transaction-Related Audit Objectives Four Phases of a Financial Statement Audit
General Objectives 1. Pland and design an audit approach based on risk
assessment procedures
1. Occurrence – recorded or disclosed transactions
2. Perform tests of controls and substantive tests of
exist.
transactions
2. Completeness – existing transactions are
3. Perform substantive analytical procedures and
recorded and disclosures are included.
tests of details of balances
3. Accuracy – recorded transactions are stated at
4. Complete the audit and issue an audit report
the correct amounts and disclosures are
appropriately measured and described.
4. Posting and Summarization – recorded
transactions are properly included in the master
files and are correctly summarized
5. Classification – transactions included in the
client’s journals are properly classified
6. Timing – transactions are recorded on the correct
dates
7. Presentation – transactions are appropriately
aggregated or disaggregated and described and
disclosure are relevant and understandable.
Balance-Related Audit Objectives
- Applied to account balances rather than classes
of transactions
- 9 balance-related audit objectives
1. Existence – amounts included exist
2. Completeness – existing amounts and related
disclosures are included
3. Accuracy – amounts included are stated at the
correct amounts and disclosures are appropriately
measured and described
4. Cutoff – transactions near the balance sheet date
are recorded in the proper period
5. Detail tie-in – details in the account balance agree
with related master file amounts, foot to the total
in the account balance, and agree with the total
in the general ledger
6. Realizable value – assets are included at the
amounts estimated to be realized
7. Classification – amounts included in the client’s
listing are properly classified
8. Rights and obligations – assets and liabilities
must be owned
9. Presentation – amounts are appropriately
aggregated or disaggregated and described, and
disclosures are relevant and understandable