Audit Responsibilities

8/3/2019 Audit Responsibilities

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Audit Responsibilities and

Objectives


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Presentation Outline

I. Financial Statement Responsibilities

II. Categories of Fraud

III. Auditor Responsibility for Detection of Illegal

Acts

IV. Managing the Audit Process

V. Phases of the Audit Process


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I. Financial StatementResponsibilities

A. Overall Objective of Financial Statement Audit

B. Client Management ResponsibilitiesC. Auditor Responsibilities

D. Terminology


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A. Overall Objective of FinancialStatement Audit

The expression of anopinion of the fairness

with which they

present fairly, in allrespects, financialposition, results of

operations, and cash

flows in conformitywith GAAP.


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B. Client Management

Responsibilities

Financial statements andinternal control.

CEO and CFO of publiccompanies certify quarterly

and annual financialstatements submitted to the

SECP. The Act also providesfor criminal penalties foranyone who knowingly

falsely certifies thestatements.


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C. Auditor Responsibilities

Auditor must plan and performthe audit to obtain

reasonable assurance aboutwhether the financial

statements are free ofmaterial misstatement,

whether caused by error orfraud.


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D. Terminology

1. Material v.Immaterial

2. Reasonable

Assurance3. Error v. Fraud

4. Professional

Skepticism


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1. Material v. Immaterial

Misstatements are usuallyconsidered material if the

combined uncorrected errors

and fraud in the financialstatements would influence areasonable person using the

statements.

It would be extremely costlyand probably impossible to hold

the auditor accountable for

immaterial errors and fraud.


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2. Reasonable Assurance

Auditors can not guarantee thatthere are no material

misstatements because:

Auditors use judgment based onsamples. Errors in judgment canoccur.

Accounting presentations are

based on complex estimates thatinvolve uncertainty.

Fraudulently prepared financialstatements are difficult to detect,

especially if there is collusion.


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3. Error v. Fraud

An error is anunintentional

misstatement of thefinancial statements,

whereas fraud isintentional.

For fraud, there is adistinction betweenmisappropriation of

assets and fraudulentfinancial reporting.


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4. Professional Skepticism Audit should bedesigned to provide

reasonable assurance ofdetecting both materialerrors and fraud in thefinancial statements.

Although an auditorshould not assume that

management isdishonest, the possibility

of dishonesty must alsobe considered.


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II. Categories of Fraud

A. Fraudulent Financial Reporting

B. Misappropriation of Assets


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A. Fraudulent FinancialReporting

Fraudulent financial reporting is oftencommitted by management.

Harms users of the financial statements by

providing incorrect information. Survey results indicate that some of the most

common techniques to misstate financialstatements are:

Recording revenues prematurelyRecording fictitious revenue

Overstatement of assets such as receivables,inventory, etc.


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B. Misappropriation of Assets

Often perpetrated byemployees and

sometimes

management. Harms investors

because assets are nolonger available.

Misappropriations oftenresult in fraudulentfinancial reporting to

hide the theft.


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III. Auditor Responsibility forDetection of Illegal Acts

A. Direct-Effect Illegal ActsB. Indirect-Effect Illegal Acts

C. Evidence Accumulation When There is

Suspicion of Illegal ActsD. Auditor Actions for Known Illegal Acts

Illegal acts as violations of laws or government

regulations other than fraud.


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A. Direct Effect Illegal Acts

Certain illegal actsdirectly affect specific

account balances.

For example, violationof federal tax laws.

Auditor responsibilityfor direct-effect illegal

acts is the same asfor errors and fraud.


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B. Indirect-Effect Illegal Acts

Indirect-effect illegalacts do not affect

financial statements

directly, but result inpotential fines.

Auditing standardsclearly state that

auditors provide noassurance that suchillegal acts will be

detected.


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C. Evidence Accumulation WhenThere is Suspicion of Illegal Acts

Auditor should inquire of management at a levelabove those likely to be involved.

Auditor should consult with the clients legal

counsel who is knowledgeable about thepotential illegal act.

Auditor should consider accumulating additionalevidence to determine whether there actually is

an illegal act.


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D. Auditor Actions for KnownIllegal Acts

Consider the effects onthe financial statements.

Consider the effect onmanagement

representations. Communicate with the

audit committee.

Report the matter to theSECP after consultationwith the auditors legal

counsel.


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IV. Managing the Audit Process

A. The Cycle ApproachB. The Testing of Client Assertions


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A. The Cycle Approach

A common way to divide an audit is to keep closelyrelated types of transactions and account

balances in the same segment. The followingsegments exist in many businesses:

Sales and collection

Acquisition and payment

Payroll and personnel

Inventory and warehousingCapital acquisition and repayment


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B. The Testing of ClientAssertions

Management assertions are implied or expressed

representations by client management about classes

of transactions and related accounts in the financial

statements.

2. Existence or occurrence

4. Completeness3. Rights and obligations

5. Valuation or allocation

1. Presentation and disclosure


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1. Presentation and Disclosure

Management Represents Auditor Tests

Financial statementcomponents are

properly combined or

separated, described

and disclosed.

Auditor tests whetherfinancial statements are

presented in accordance

with GAAP.


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2. Existence or Occurrence


Existence is concerned

with whether assets,

obligations, and equities

included in the balance

sheet actually existed on

the balance sheet date. Transactions recorded

occurred during the

accounting period.

Auditor tests for

overstatement of items


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3. Rights and Obligations


Client organization

possesses ownershiprights to recorded assets.

Client records show

liabilities owed as of the

balance sheet date.

Auditor tests asset

ownership and liability

claims.


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4. Completeness


All transactions andaccounts that should be

presented in the

financial statements are

included.

Auditor tests for

understatement of items


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5. Valuation or Allocation


All asset, liability, equity,revenue, and expense

accounts have been

included in the financial

statements at appropriateamounts.

Auditor tests whether

account balances are valued

and allocated in accordance

with GAAP.


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V. The Phases of the AuditProcess

A. Phase I Plan and Design an AuditApproach

B. Phase II Tests of Controls and

Substantive Tests of TransactionsC. Phase III Analytical Procedures and Test

of Details of Balances

D. Phase IV - Complete the Audit and Issue anAudit Report


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A. Phase I Plan and Design anAudit Approach

Two key aspects are imperative in the planningprocess:

Obtain knowledge the clients business strategies

and processes and assess risks. This is used tohelp assess the risk of misstatement in the

financial statements.

Understand internal control and assess controlrisk. Strong internal controls may justify less

accumulation of evidence.


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B. Phase II Tests of Controls andSubstantive Tests of Transactions

Control risk is the risk that internal controls willfail to catch inappropriate information reporting.To justify reducing the planned assessed control

risk when internal controls are strong, theauditor must test compliance with controls.

Depending on the assessed level of control risk,the auditor will then perform substantive testingof transactions to verify the monetary amounts

of transactions.


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C. Phase III Analytical Procedures and Testsof Details of Balances

Analytical procedures use comparisons andrelationships to assess whether account

balances or other data appear reasonable.

Tests of details of balances involve specificprocedures to test for the monetary

misstatement of balances in the financialstatements. Most of this evidence comes from a

source outside of the client.

D Ph IV C l h A di


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D. Phase IV Complete the Auditand Issue a Report

After completion ofthe audit work, it is

necessary to combinethe information

obtained and decide ifthe financial

statements are fairlystated.

Appropriate report isthen written.


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Summary

1. Client and auditor responsibilities

2. Fraudulent financial reporting vs.

misappropriation of assets.

3. Testing client assertions

4. Phases of the audit process

Audit Responsibilities

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