AUDIT RESPONSIBILITIES AND

OBJECTIVES

LECTURER: SHAUNTAI BURKE DATE: FEBRUARY 19, 2024 TIME: 6PM

ICEBREAKER

BIBLE QUIZ
 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.
 AS AN AUDITOR:
GROUP 1
I. DISCUSS THE ACTIONS AN
AUDITOR SHOULD TAKE
WHEN AN ILLEGAL ACT IS
IDENTIFIED OR SUSPECTED.
 AS AN AUDITOR:
GROUP 2
I. DESCRIBE WHAT IS MEANT BY THE CYCLE
APPROACH TO AUDITING. WHAT ARE THE
ADVANTAGES OF DIVIDING THE AUDIT INTO
DIFFERENT CYCLES?
II. DISCUSS THE DIFFERENCES BETWEEN
ERRORS, FRAUDS, AND ILLEGAL ACTS. GIVE
AN EXAMPLE OF EACH.
 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
accounting policies, maintaining adequate internal
control, and making fair representations in the
financial statements rests with management rather
than with the auditor. Because they operate the
business daily, a company’s management knows
more about the company’s assets, liabilities, and
equity than the auditor.
In contrast, the auditor’s knowledge of these matters
and internal control is limited to that acquired during
the audit.
The annual reports of many public companies
include a statement about management’s
responsibilities and relationship with the CPA firm.
Management’s responsibility for the integrity and
fairness of the representations (assertions) in the
financial statements carries with it the privilege of
determining which presentations and disclosures it
considers necessary.
If management insists on financial statement
disclosure that the auditor finds unacceptable, the
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
However, the auditor's
The auditor has a responsibility to
responsibility for the financial
plan and perform the audit to obtain
statements he or she has audited is
reasonable assurance about whether
confined to the expression of his or
the financial statements are free of
her opinion on them. You should
material misstatement, whether
note that the audit of the financial
caused by error or fraud.
statement does not relieve
The auditor's responsibility is to
management or those charged with
express an opinion on the financial
governance of their
statements and may make
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.
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

When the auditor also MATERIAL VERSUS IMMATERIAL

reports on the MISSTATEMENTS
 Misstatements are usually considered material if the
effectiveness of
internal control over combined uncorrected errors and fraud in the financial
financial reporting, the statements would likely have changed or influenced the
auditor is also decisions of a reasonable person using the statements.
 Although it is difficult to quantify a measure of materiality,
responsible for
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 types of misstatements: errors and
fraud. Either type of misstatement can
be material or immaterial. An error is
an unintentional misstatement of the
financial statements, where as fraud is
intentional.
Two examples of error are a
mistake in extending price times
quantity on a sales invoice and
overlooking older raw materials
in determining the lower of cost
or market for inventory.
 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
the auditor to obtain complete
assurance about the correctness of each
class of transactions, resulting in less
than complete assurance about the
ending balance in accounts receivable.
 Auditors have found that, generally,
the most efficient and effective way to
conduct audits is to obtain some
combination of assurance for each
class of transactions and for the ending
balance in the related accounts.
 For any given class of transactions, several audit
objectives must be met before the auditor can
conclude that the transactions are properly recorded.
These are called transaction-related audit
objectives in the remainder of this book. For
example, there are specific sales transaction-related
audit objectives and specific sales returns and
allowances transaction-related audit objectives.
 Similarly, several audit objectives must be met for
each account balance. These are called balance-
related audit objectives. For example, there are
specific accounts receivable balance-related audit
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.
REVIEW QUESTION
REVIEW QUESTION
 REVIEW QUESTION
CYCLE
CYCLE JOURNALS INCLUDED
JOURNALS INCLUDED
GENERALIN BALANCEINCLUDED
THE ACCOUNTS
LEDGER SHEET IN THE CYCLE INCOME STATEMENT
IN THE CYCLE CYCLE BALANCE SHEET INCOME STATEMENT
GENERAL LEDGER ACCOUNTS INCLUDED IN THE CYCLE

Sales and Collection Sales Journal Cash in bank Sales

Trade accounts receivable Sales returns and allowance
Cash receipts journal Other accounts receivable
General Journal Bad debt expense
Allowance for uncollectable accounts

Acquisition and
payment
Payroll and Personnel

Inventory and
Warehousing
Capital acquisition and
repayment
 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-DISTINC
TIVE-ROLES-IN-ORGANIZATIONAL-GOVERNANCE.PDF