Auditing: The Art and Science of Assurance

Engagements
Fourteenth Canadian Edition

Chapter 4
Audit Responsibilities and
Objectives

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Learning Objectives (1 of 2)
1. Explain the objective of conducting an audit of financial
statements.
2. Explain management’s responsibility for the financial
statements and internal controls.
3. Explain the responsibilities of those in charge of
governance for financial statements and internal controls.
4. Explain the auditor’s responsibility for discovering material
misstatements due to fraud or error.
5. Explain and apply the key elements of an effective
professional judgment process.
6. Describe the need to maintain professional skepticism
when conducting the audit.
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Learning Objectives (2 of 2)
7. Identify the benefits of a cycle approach to segmenting the
audit.
8. Explain how the auditor obtains assurance by auditing
classes of transactions and ending balances in accounts,
including presentation and disclosure.
9. Distinguish among the management assertions about
financial information.
10. Link management assertions with audit objectives.
11. Explain how the audit process ensures that audit objectives
are met and evidence is sufficient and appropriate.

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The Objective of Conducting an Audit of
Financial Statements
• CAS 200 states that an audit of financial statements is to
be conducted by an independent auditor, with the objective
of expressing an opinion on those financial statements.
• This opinion is an assessment of whether the financial
statements are both free from material misstatement, and
presented fairly in conformity with an applicable financial
reporting framework, as the criteria for the assessment.

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Management’s Responsibilities (1 of 2)
• CAS 200 sets out management’s responsibilities:
– Adopt sound and appropriate accounting policies;
– Implement and maintain adequate internal controls; and
– Provide fair representations in the financial statements.

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Management’s Responsibilities (2 of 2)
• CAS 200 also highlights that it is management’s
responsibility to provide the auditor with the following:
– Access to all information that is relevant to the preparation of the
financial statements such as records, documentation, and other
matters;
– Any additional information that the auditor may request; and
– Unrestricted access to persons within the entity from whom the
auditor determines it necessary to obtain audit evidence.

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Responsibilities of Those Charged with
Governance
• In most cases, management is responsible for financial
statement preparation and internal controls, while those
charged with governance are responsible for the
oversight of management and the financial statement
audit.
• As part of those oversight responsibilities, those in charge
of governance approve the audited financial
statements.
• The audit committee is responsible for oversight of
management in relation to financial statement preparation
and internal controls and the external auditor.

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Auditor Responsibilities
• CAS 200 also sets out the auditor’s responsibilities:
– Provide reasonable (not absolute) assurance that financial
statements are free from material misstatements; and
– To report on the financial statements, and communicate as
required by the CASs, in accordance with the auditor’s findings.

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Material Versus Immaterial Misstatements
• Misstatements are usually considered material if the
combined uncorrected errors and fraud in the financial
statements would likely have changed or influenced the
decisions of a reasonable person using the statements.

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Error Versus Fraud
• An error is an unintentional misstatement.
• Fraud and other irregularities are intentional
misstatements.
• For fraud, a distinction can be drawn between
“misappropriation of assets,” often called “defalcation” or
“employee fraud,” and “fraudulent financial reporting,” often
called “management fraud.”
• Auditing standards require that an audit be designed to
provide reasonable assurance of detecting both.

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Fraudulent Financial Reporting vs
Misappropriation of Assets
• Fraudulent financial reporting harms users by providing
them with incorrect financial statement information for their
decision making. It is usually committed by management.
• When assets are misappropriated, stockholders, creditors,
and others are harmed because assets are no longer
available to their rightful owners.
• Usually, but not always, theft of assets is perpetrated by
employees.

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Auditor’s Responsibility to Consider Laws
and Regulations (1 of 2)
• CAS 250 requires that the auditor get written
representation from management (or those charged with
governance of the organization) with respect to
noncompliance with laws or regulations or possible acts of
noncompliance that would affect the financial statements
or their notes.
• Other than inquiry of management, the auditor should not
search for such illegal acts unless there is reason to
believe they may exist.

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Auditor’s Responsibility to Consider Laws
and Regulations (2 of 2)
• To identify instances of noncompliance with other laws and
regulations that may have a material effect on the financial
statements, the auditor should:
– Inquire of management and those charged with governance about
whether the entity is in compliance with such laws and regulations.
– Inspect correspondence, if any, with the relevant licensing or
regulatory authorities.
– The auditor should communicate with those charged with
governance matters involving noncompliance with laws and
regulations.

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Auditor’s Responsibility to Evaluate Going
Concern
• CAS 570 “Going Concern”, explains that it is the auditor’s
responsibility to obtain sufficient appropriate audit evidence
regarding, and to conclude on, the appropriateness of
management’s use of the going-concern basis of
accounting in the preparation of the financial statements.
• In addition, based upon the evidence obtained, the auditor
is responsible for concluding whether there is a material
uncertainty about the entity’s ability to continue as a going
concern.

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A Framework for Professional Judgment (1 of 2)
• Professional judgment in auditing is the application of
relevant knowledge and experience, within the context
provided by auditing and accounting standards and Rules
of Professional Conduct, in reaching decisions where a
choice must be made between alternative possible
courses of action.

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A Framework for Professional Judgment (2 of 2)

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Professional Skepticism
• The auditing standards note that professional skepticism
—a “questioning mind”—is necessary for the critical
assessment of audit evidence.
• Sound professional judgment also requires the auditor to
exercise objectivity.
• In addition to using a judgment framework, awareness of
judgment traps and biases (often referred to as judgment
tendencies) can assist auditors and auditing students in
making better judgments.

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Potential Judgment Traps and Biases
• Confirmation Bias
– This judgment tendency refers to the auditors’ potential to put
more weight on information that is consistent with their initial
beliefs or preferences.
– The end result may be that the auditor does not adequately
consider contradictory evidence.
• Overconfidence Bias
– Challenge opinions, experts, and underlying assumptions
• Anchoring
– Solicit input from others
• Availability
– Consider why something comes to mind
• Table 4-2 notes judgment traps and how to avoid them.
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Cycle Approach to Segmenting an Audit
• A common way to divide an audit is to keep closely related
types (or classes) of transactions and account balances in
the same segment. This is called the cycle approach.
– A convenient way to separate transactions for study and
assessment during the audit.
– Related types (or classes) of transactions are part of the same
cycle.

• To understand the logic of using the cycle approach, think

about the way in which transactions are reported in
journals and summarized in the general ledger, trial
balance, and financial statements.

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Financial Statement Cycles
• There are five basic cycles:
– Revenue and collection;
– Acquisition and payment ;
– Human resources and payroll;
– Inventory and distribution; and
– Capital acquisition and repayment.

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Cycles: Transaction Flow into Journals and
Financial Statements

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Cycles: Relationships Among Cycles
• Transaction cycles are of major importance in the conduct
of the audit.
• Although auditors take care to interrelate different cycles at
different times and be aware of the interrelationships
among the cycles, they must treat the cycles somewhat
independently in order to manage complex audits
effectively.
• Refer to Figure 4-4 for detail on the relationships among
transaction cycles.

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Setting Audit Objectives
• The auditor will develop balance-related audit objectives
for ending balances as well as presentation and
disclosure-related audit objectives for the relevant financial
statement disclosures for each cycle.
• How these audit objectives are set is based upon more
specific factors, which is the auditors’ risk assessment of
assertions.

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Management Assertions and Audit
Objectives (1 of 2)
• Implied or expressed representations by management
about:
(i) classes of transactions or events,
(ii) related account balances in the financial statements, and
(iii) the classification, presentation, or disclosure of information in the
financial statements.

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Management Assertions and Audit
Objectives (2 of 2)
• International and Canadian auditing standards
(CAS 315.A111) classify assertions into three categories:
– Assertions about classes of transactions and events for the period
under audit.
– Assertions about account balances at period-end.
– Assertions about financial statement presentation and disclosure.

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Management Assertions (1 of 2)
Table 4-4 Management Assertions for Each Category of Assertions
Assertions About Classes of Assertions About Account Assertions About Presentation and
Transactions and Events Balances Disclosure
Occurrence—Transactions and events Existence—Assets, liabilities, and Occurrence and rights and obligations
that have been recorded have equity interests exist. —Disclosed events and
occurred and pertain to the entity. transactions have occurred and
pertain to the entity.
Completeness—All transactions and Completeness—All assets, liabilities, Completeness—All disclosures that
events that should have been and equity interests that should should have been included in the
recorded have been recorded. have been recorded have been financial statements have been
recorded. included.
Accuracy—Amounts and other data Valuation and allocation—Assets, Accuracy and valuation—Financial
relating to recorded transactions liabilities, and equity interests are and other information is disclosed
and events have been recorded included in the financial statements appropriately and at appropriate
appropriately. at appropriate amounts and any amounts.
resulting valuation adjustments are
appropriately recorded.

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Management Assertions (2 of 2)
Table 4-4 Continued
Assertions About Classes of Assertions About Account Assertions About Presentation and
Transactions and Events Balances Disclosure
Cutoff—Transactions and events have  Blank  Blank
been recorded in the correct
accounting period.
Classification—Transactions and   Blank Classification and understandability—
events have been recorded in the Financial and other information is
proper accounts. appropriately presented and
described and disclosures are
clearly expressed.
 Blank Rights and obligations—The entity  Blank
holds or controls the rights to
assets, and liabilities are the
obligation of the entity.

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Linking Assertions with Audit Objectives
• Management makes several assertions about transactions
that are applied to other events reflected in the accounting
records.
• The auditor develops corresponding transaction-related
audit objectives.
• Transaction-related audit objectives are audit objectives
that must be met before the auditor can conclude that the
total for any given class of transactions is fairly stated.

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Assertions and Transaction-Related Audit
Objectives
• Occurrence: Do recorded transactions exist?
• Completeness: Have all transactions been included and
recorded?
• Accuracy: Were transactions recorded correctly?
• Cut-off: Were transactions and amounts recorded on the
correct dates?
• Classification: Are the transactions included in the client’s
journals properly classified?

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Assertions and Balance-Related Audit
Objectives
• Existence: Do all amounts included exist?
• Rights (Ownership)/Obligations: Are the assets owned?
Do the liabilities belong to the entity?
• Completeness: Are all amounts recorded?
• Valuation: Are the assets recorded at the amounts
estimated to be realized?
• Allocation: Are all amounts included appropriate?

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Assertions and Presentation- and
Disclosure-Related Audit Objectives
• Four audit objectives that must be met before the auditor
can conclude that presentation and disclosures are fairly
stated are:
– Occurrence and Rights and Obligations
– Completeness
– Accuracy and Valuation
– Classification and Understandability

• The overall purpose of all of the above audit objectives is

to assess whether the economic reality of what actually
occurred is portrayed in the statements.

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The Audit Process: How Audit Objectives
Are Met
• The auditor must obtain sufficient appropriate audit
evidence to support all management assertions in the
financial statements by accumulating evidence in support
of some appropriate combination of transaction-related,
balance-related, presentation and disclosure audit
objectives.

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The Audit Process
• The auditor is expected to design a plan that achieves an
appropriate combination of audit objectives, and the
evidence that must be accumulated to meet these
objectives, by following the structured audit process shown
in Figure 4-8.

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The Audit Process: Risk Assessment
• In the risk assessment section, the auditor identifies what
could go wrong with the financial statements and the
approaches for dealing with the risks.
– Client Acceptance and Continuance—engagement acceptance
risk
– Audit Planning—understanding the entity and its environment
– Assess Risk of Material Misstatement—identify and assess
RMM at the financial statement level and at the account and
assertion level

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The Audit Process: Risk Response
• After the auditor completes the risk assessment, the risk
response is developed, consisting of audit programs and
tests, to address those risks.
– Develop Risk Response—develop overall response (overall
audit strategy), determine audit strategy (approach) for each
cycle, finalize audit plan, and develop audit programs and further
procedures for each cycle
– Perform Risk Responses—gather audit evidence, sampling
decisions, perform tests of controls (if relying upon controls),
perform substantive analytical procedures, and perform
substantive tests (including tests of details)
– Conclusion—Complete final evidence gathering, evaluate results
of tests completed, and conclude if gathered evidence is sufficient,
reliable, and appropriate
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The Audit Process: Reporting
• The final step of the audit process is the audit report.
– Reporting—determine type of audit opinion to issue and issue
audit report

• When the audit is completed and those in charge of

governance have approved the financial statements, the
public accountant will issue an auditor’s report to
accompany the client’s published financial statements.

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