Part l ( Chapters 6-12) THE AUDIT PROCESS Part lI presents the audit process in a manner that will enable you to apply the concepts developed in these chapters to any audit area. Arens, Loebbecke; Auditing, 8/E @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. 6 Part II THE AUDIT PROCESS (Chapters 6-12) Part II presents the audit process in a manner that will enable you to apply the concepts developed in these chapters to any audit area
Other objectives are secondary AUDIT RESPONSIBILITIES AND OBJECTIVES Audit Objective Primary objective of the audit is to express an opinion on the financial statements Arens, Loebbecke; Auditing, 8/E @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. AUDIT RESPONSIBILITIES AND OBJECTIVES Audit Objective Primary objective of the audit is to express an opinion on the financial statements Other objectives are secondary
FIGURE 6-1 Steps to Develop Audit Objectives Understand objectives and responsibilities for the audit Divide financial statements into cycles Know management assertions a bout accounts Know specific audit cuves for Know general audit classes of objectives for transactions and classes of accounts transactions and accounts @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. FIGURE 6-1 Steps to Develop Audit Objectives Understand objectives and responsibilities for the audit Divide financial statements into cycles Know management assertions about accounts Know general audit objectives for classes of transactions and accounts Know specific audit objectives for classes of transactions and accounts 1 2 3 4 5
Management Vs. Auditor Responsibilities Management Auditor Financial statement.Issue opinion on fairness of .nternal controls FS’s Arens, Loebbecke; Auditing, 8/E @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Management vs. Auditor Responsibilities Management •Financial statement •Internal controls Auditor •Issue opinion on fairness of F/S’s
Issue Opinion on Financial Statement Other obiectives are secondary Provides reasonable assurance financial statement are free from material misstatement Audit performed with professional skepticism Arens, Loebbecke; Auditing, 8/E @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Issue Opinion on Financial Statement Other objectives are secondary Provides reasonable assurance financial statement are free from material misstatement Audit performed with professional skepticism
TABLE 6-1 The Three SAS 82 Categories of Risk Factors for Fraudulent Financial Reporting Three Examples of Each CATEGORY 1 CATEGORY 2 CATEGORY 3 Management's Characteristics and influence over the Operating Characteristics Control environment Industry Conditions and Financial Stability These pertain to management 's hese involve the economic and These pertain to the nature and complexity of abilities, pressures, style, and attitude regulatory environment in which the the entity and its transactions, financial relating to internal control and the entity operates. condition, and profitability financial reporting process Examples of risk Factors Examples of risk factors Examples of Risk factors A motivation for management to New accounting statutory,of Significant pressure to obtain engage in fraudulent financial regulatory requirements that could additional capital necessary to stay reporting such as an excessive nterest impair the financ ial stability or competitive considering the financ ial by management to maintain or increase profitabil ity of the entity position of the entity. the entity's stock price or earnings Declining industry with increasing Significant, unusual, or highly trend through the use of unusuall business failures and significant complex transactions, especially those aggressive accounting practices declines in customer demand close to yearend, that pose difficult A failure by management to display Rapid changes in the industry, such substance over form'questions and communicate an approprate as high vulnerabil ity to rapidly Overly complex organizational attitude regarding internal control and changing technology or rapid product structure involving numerous or the financial reporting process, such as unusual legal entities, managerial lines domination of management by a single of authority, or contractual person or small group without arrangements without apparent compensating controls busi High turnover of senior management. counsel or board members Arens, Loebbecke; Auditing, 8/E @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. CATEGORY 1 Management’s Characteristics and Influence over the Control Environment These pertain to management’s abilities, pressures, style, and attitude relating to internal control and the financial reporting process. CATEGORY 2 Industry Conditions These involve the economic and regulatory environment in which the entity operates. CATEGORY 3 Operating Characteristics and Financial Stability These pertain to the nature and complexity of the entity and its transactions, financial condition, and profitability Examples of Risk Factors • A motivation for management to engage in fraudulent financial reporting, such as an excessive interest by management to maintain or increase the entity’s stock price or earnings trend through the use of unusually aggressive accounting practices. • A failure by management to display and communicate an appropriate attitude regarding internal control and the financial reporting process, such as domination of management by a single person or small group without compensating controls. • High turnover of senior management, counsel, or board members. Examples of Risk Factors • New accounting, statutory, or regulatory requirements that could impair the financial stability or profitability of the entity. • Declining industry with increasing business failures and significant declines in customer demand. • Rapid changes in the industry, such as high vulnerability to rapidly changing technology or rapid product obsolescence. Examples of Risk Factors • Significant pressure to obtain additional capital necessary to stay competitive considering the financial position of the entity. • Significant, unusual, or highly complex transactions, especially those close to yearend, that pose difficult “substance over form” questions. • Overly complex organizational structure involving numerous or unusual legal entities, managerial lines of authority, or contractual arrangements without apparent business purpose. TABLE 6-1 The Three SAS 82 Categories of Risk Factors for Fraudulent Financial Reporting & Three Examples of Each
TaBLE 6-2 The Two SAs 82 Categories of risk Factors for Misappropriation of Assets and Two Examples of each CATEGORY 1 CATEGORY 2 Susceptibility of Assets to Misappropriation Controls These pertain to the nature of an entity 's assets These involve the lack of controls designed to and the degree to which they are subject to theft prevent or detect misappropriations ofassets Examples of risk Factors Examples of risk Factors Large amounts of cash on hand or processed Lack of appropriate management oversight Easily convertible assets, such as bearer such as inadequate supervision or monitorin bonds, diamonds, or computer chips of remote locations Fixed asset characteristics. such as small assets susceptible to misappropriation ctl a Inadequate record keeping with respec size, marketability, or lack of ownership identification Lack of timely and appropriate documentation for transactions. such as credits for merchand ise Arens, Loebbecke; Auditing, 8/E @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. TABLE 6-2 The Two SAS 82 Categories of Risk Factors for Misappropriation of Assets and Two Examples of Each CATEGORY 1 Susceptibility of Assets to Misappropriation These pertain to the nature of an entity’s assets and the degree to which they are subject to theft. CATEGORY 2 Controls These involve the lack of controls designed to prevent or detect misappropriations of assets. Examples of Risk Factors • Large amounts of cash on hand or processed • Easily convertible assets, such as bearer bonds, diamonds, or computer chips • Fixed asset characteristics, such as small size, marketability, or lack of ownership identification Examples of Risk Factors • Lack of appropriate management oversight such as inadequate supervision or monitoring of remote locations • Inadequate record keeping with respect to assets susceptible to misappropriation • Lack of timely and appropriate documentation for transactions, such as credits for merchandise returns
Responsibilities for Discovering Illegal Acts Direct-Effect Illegal Acts(same as errors irregs) Indirect-Effect Illegal Acts(No assurance) Evidence accumulation when there is no reason to Believe Indirect-Effect Illegal Acts exist(no resp Evidence Accumulation and other actions when There is Reason to believe direct-or Indirect-Effect Illegal acts May exist(inquire, consult, consider more evidence) Actions when the auditor Knows of an Illegal Act(consider f/s Effect, BODS/Audit Cte, collect sufficient evidence) Arens, Loebbecke, Auditing, 8/E @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Responsibilities for Discovering Illegal Acts • Direct-Effect Illegal Acts (same as errors & irregs) • Indirect-Effect Illegal Acts (No assurance) • Evidence Accumulation When There is No Reason to Believe Indirect-Effect Illegal Acts exist (no resp.) • Evidence Accumulation and Other Actions When There is Reason to Believe Direct - or Indirect-Effect Illegal Acts May Exist (inquire, consult, consider more evidence) • Actions when the Auditor Knows of an Illegal Act (consider f/s Effect, BOD’s/Audit Cte., collect sufficient evidence)
FIGURE 6-3 TRANSACTIONS JOURNALS LEDGERS. TRIAL BALANCES Sales Sales AND FINANCIAL STATEMENTS Journal General ledger Cash receipts Cash and Subsidiary Receipts journal Records Acquisition of Acquisition Goods services Journal General ledger Cash TRial balance Cash Disbursements Disbursements Journal Financial Payroll services Statements disbursements Payroll Journal Allocation and Adjustments General Journal Arens, Loebbecke, Auditing, 8/E The Cycle Approach to segmenting an audit @2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. Sales Sales Journal Cash Receipts Cash Receipts Journal Acquisition of Goods & Services Acquisition Journal Cash Disbursements Cash Disbursements Journal Payroll Services & Disbursements Payroll Journal Allocation and Adjustments General Journal General Ledger and Subsidiary Records General Ledger Trial Balance Financial Statements TRANSACTIONS JOURNALS LEDGERS, TRIAL BALANCES, AND FINANCIAL STATEMENTS FIGURE 6-3 The Cycle Approach to segmenting an audit
FIGURE 6-5 Relationships among Transaction Cycles General Cash Capital Acquisition and Repayment Cvcle Sales and Acquisition and Payroll and Collection Payment Personnel Cycle ycle Cycle Inventory and Warehousing Cvcle Arens, Loebbecke, Auditing, 8/E C2000 Prentice Hall. In
Arens, Loebbecke; Auditing, 8/E ©2000 Prentice Hall, Inc. FIGURE 6-5 Relationships among Transaction Cycles General Cash Capital Acquisition and Repayment Cycle Sales and Collection Cycle Inventory and Warehousing Cycle Acquisition and Payment Cycle Payroll and Personnel Cycle
