Chapter 4 - Audit Responsibilities and Objectives

Question 1

What is the objective of conducting and audit of financial statements?

Answer 1

To express an opinion on whether the financial statements are both free from material misstatement, and presented fairly in conformity with an applicable financial reporting framework.

Question 2

What are the 3 responsibilities of management?

Answer 2

1. Adopt sound and appropriate accounting policies
2. Implement and maintain adequate internal controls
3. Provide fair representations in the financial statements

Question 3

It is management’s responsibility to provide the auditor with the following 3 things:

Answer 3

1. Access to all information that is relevant to the preparation of the financial statements such as records, documentation, and other matters
2. Any additional information that the auditor may request
3. Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.

Question 4

Who would be considered “those charged with governance” in a public company vs. a private company?

Answer 4

Public company: the audit committee

Private company: the board of directors

Question 5

What are the responsibilities of those charged with governance? (2)

Answer 5

1. The oversight of management and the financial statement audit
2. Approving the audited financial statements

Question 6

What are the two main responsibilities of auditors?

Answer 6

1. Provide reasonable (not absolute) assurance that financial statements are free from material misstatements
2. To report on the financial statements, and communicate as required by the CASs, in accordance with the auditor’s findings.

Question 7

When are misstatements considered material?

Answer 7

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.

Question 8

What is the difference between errors and fraud?

Answer 8

Errors are UNINTENTIONAL misstatements.

Fraud and other irregularities are INTENTIONAL misstatements.

Question 9

What are the two types of fraud?

Answer 9

1. Misappropriation of assets

2. Fraudulent financial reporting

Question 10

What is fraudulent financial reporting? How does it harm financial statement users? Who usually commits it? Give an example.

Answer 10

Fraudulent financial reporting is the intentional misstatement or omission of amounts or disclosures in financial statements to deceive users.

Harms users by providing them with incorrect financial statement information for their decision making.

Usually committed by MANAGEMENT.

Example: The intentional overstatement of sales near the balance sheet date to increase reported earnings

Question 11

What is misappropriation of assets? How does it harm financial statement users? Who usually commits it? Give an example.

Answer 11

Misappropriation of assets (defalcation) is the theft of an entity’s assets.

When assets are misappropriated, stockholders, creditors, and others are harmed because assets are no longer available to their rightful owners.

Usually committed by EMPLOYEES.

Example: A clerk taking cash at the time a sale is made and not entering the sale in the cash register

Question 12

What is professional skepticism?

Answer 12

A questioning mind and a critical examination of evidence.

The appropriate level of professional skepticism varies depending upon the risks of the particular situation.

Question 13

What are judgement traps?

Answer 13

Common systematic judgement tendencies and biases that can impede the quality of the professional judgement process

Question 14

What is confirmation bias and how can you avoid it?

Answer 14

Confirmation Bias – the auditor’s potential to put more weigh on information that is consistent with their initial beliefs or preferences

How to avoid: Consider alternative explanations

Question 15

What is overconfidence bias and how can you avoid it?

Answer 15

Overconfidence Bias – the potential for the auditor to overestimate his or her own ability to perform tasks or to make accurate risk assessments.

How to avoid: Challenge opinions and experts

Question 16

What is anchoring and how can you avoid it?

Answer 16

Anchoring – when the auditor is “anchored” by the initial numerical number and not adjusting sufficiently when forming a final judgement.

How to avoid: Solicit input from others

Question 17

What is the availability judgment trap and how can you avoid it?

Answer 17

Availability – can cause auditors to estimate or forecast the likelihood of an event based on how easily they can recall an example or instance of that event.

E.g., although there is much discussion of fraudulent financial statements, for most auditors this is a rare event – do not have a vivid fraud client experience to draw upon and can potentially miss fraud when they come across it

How to avoid: consult with others, obtain objective data

Question 18

What is the cycle approach to segmenting an audit?

Answer 18

A method of dividing an audit by keeping closely related types of transactions and account balances in the same segment

Question 19

What are the 5 basic cycles?

Answer 19

RAPIC

1. Revenue and collection
2. Acquisitions and payments
3. Payroll and human resources
4. Inventory and distribution
5. Capital acquisition and repayment

Question 20

What are management assertions?

Answer 20

Management assertions are implied or expressed representations by management about:

(1) classes of transactions
(2) related account balances
(3) classification, presentation, or disclosures in the financial statements

Question 21

What are transaction-related audit objectives?

Answer 21

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.

Question 22

Describe the 6 management assertions about ACCOUNT BALANCES that must be met:

1. Existence
2. Rights and Obligations
3. Completeness
4. Accuracy, valuation and allocation
5. Classification
6. Presentation

Answer 22

(i) Existence — assets, liabilities, and equity interests exist.
(ii) Rights and Obligations — the entity holds or controls the rights to assets, and liabilities are the obligations of the entity.
(iii) Completeness — all assets, liabilities and equity interests that should have been recorded have been recorded, and all related disclosures that should have been included in the financial statements have been included.
(iv) Accuracy, valuation and allocation — assets, liabilities and equity interests have been included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments have been appropriately recorded, and related disclosures have been appropriately measured and described.
(v) Classification— assets, liabilities and equity interests have been recorded in the proper accounts.
(vi) Presentation — assets, liabilities and equity interests are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework.

Question 23

Describe the 6 management assertions about CLASSES OF TRANSACTIONS that must be met:

1. Occurrence
2. Completeness
3. Accuracy
4. Cutoff
5. Classification
6. Presentation

Answer 23

(i) Occurrence — transactions and events that have been recorded or disclosed, have occurred and such transactions and events pertain to the entity.
(ii) Completeness — all transactions and events that should have been recorded have been recorded, and all related disclosures that should have been included in the financial statements have been included.
(iii) Accuracy — amounts and other data relating to recorded transactions and events have been recorded appropriately, and related disclosures, have been appropriately measured and described.
(iv) Cutoff — transactions and events have been recorded in the correct accounting period.
(v) Classification— transactions and events have been recorded in the proper accounts.
(vi) Presentation — transactions and events are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework.

Question 24

How do auditors meet the audit objectives?

Answer 24

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 and balance-related audit objectives.

Question 25

What are the 7 steps of the audit process and what occurs at each of these steps?

Answer 25

1. Client Acceptance - engagement acceptance risk
2. Audit Planning - understanding the entity and its environment
3. Assess Risk of Material Misstatement - at financial statement level, account, and assertion level
4. 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
5. 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)
6. Conclusion - Complete final evidence gathering, evaluate results of tests completed, and conclude if gathered evidence is sufficient, reliable, and appropriate
7. Reporting - determine type of audit opinion to issue and issue audit report