Auditing and Assurance Services

Seventeenth Edition, Global Edition

Chapter 5
Audit Responsibilities and
Objectives

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Learning Objectives (1 of 3)
5.1 Explain the objective of conducting an audit of financial
statements and an audit of internal controls
5.2 Distinguish management’s responsibility for the
financial statements from the auditor’s responsibility for
verifying those statements
5.3 Explain the auditor’s responsibility for discovering
material misstatements due to fraud or error
5.4 Describe the need to maintain professional skepticism
when conducting an audit

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Learning Objectives (2 of 3)
5.5 Describe the key elements of an effective professional
judgment process
5.6 Identify the benefits of a cycle approach to segmenting
the audit  group similar accounts for audit
5.7 Describe why the auditor obtains assurance by
auditing transactions and ending balances, including
presentation and disclosure
5.8 Distinguish among the management assertions about
financial information (Very important)

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Learning Objectives (3 of 3)
5.9 Link transaction-related audit objectives to
management assertions for classes of transactions
(Very important)
5.10 Link balance-related audit objectives to management
assertions (Very important)
5.11 Explain the relationship between audit objectives and
the accumulation of audit evidence (Very important)

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Learning Objective 5.1
Explain the objective of conducting an audit of financial
statements and an audit of internal controls

Why we do audit?

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Objective of Conducting an Audit of
Financial Statements
• The purpose of an audit is to:
– Provide financial statement users with an opinion by
the auditor on
 Whether the financial statements are presented
fairly, in all material respects, in accordance with
the applicable financial accounting framework,
which enhances the degree of confidence that
intended users can place in the financial statements

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Figure 5.1 Steps to Develop Audit Objectives

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Learning Objective 5.2
Distinguish management’s responsibility for the financial
statements from the auditor’s responsibility for verifying
those statements

Precisely: prepare f/s

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Management’s Responsibilities
• Management’s responsibility includes:
– Adopting sound accounting policies
– Maintaining adequate internal control
– Making fair representations in the financial statements
– Certifying the quarterly and annual financial
statements

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Figure 5.2 International Business
Machines Corporation’s Report of
Management

Source: IBM 2017 Annual Report: Report of Management.

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Let’s Discuss (1 of 6)
• State the objective of the audit of financial statements.
– In general terms, how do auditors meet that objective?
• Describe management’s responsibility for the financial
statements.
– Do you believe the CEO and CFO of a public
company perceive an even greater responsibility as a
result of the Sarbanes–Oxley Act requirement to certify
the financial statements submitted to the SEC?

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Learning Objective 5.3
Explain the auditor’s responsibility for discovering material
misstatements due to fraud or error

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Auditor’s Responsibilities (1 of 2)
• The overall objectives of the auditor are 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 on whether the financial statements are
presented fairly, in all material respects, in accordance with an
applicable financial reporting framework

– We don’t really care if it is a fraud or an error

– What we care  if it is material, we need to catch them

– Fraud: intentional
– Error: unintentional

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Auditor’s Responsibilities (2 of 2)
• The overall objectives of the auditor are to:
– Report on the financial statements, and communicate as required by
auditing standards, in accordance with the auditor’s findings
• Auditor are also responsible to:
– Detect material unintentional mistakes (errors)
– Detect material fraud
– Consider laws and regulations relevant to the client
 (Law, e.g. tax law) May have a direct effect on f/s
 (Law, e.g. bank licensing requirement) May have no direct effect on
f/s
– Does not have an effect now, but in future if bank violates the
law, it will affect the going concern for the bank  then affect
 When non-compliance is identified or suspected, find out what
happen, obtain understanding and evaluate possible effects

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Learning Objective 5.4
Describe the need to maintain professional skepticism when
conducting an audit

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Professional Skepticism (1 of 2)
• Audit must be planned and performed with an attitude of professional
skepticism
• Professional skepticism consists of two primary components:
– A questioning mind (=You believe your clients but more important
is you need to verify/ check what they told you)
 offset the natural bias to want to trust the client
 Approach the audit with a “truth but verify” mental outlook

– A critical assessment of the audit evidence (=you need to ask

questions + find out inconsistencies)
 Includes asking probing questions and paying attention to
inconsistencies

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Professional Skepticism (2 of 2)
• 6 Elements of professional skepticism include:
– Questioning mindset (Have a mindset that you want to ask questions)
 a disposition to inquiry with some sense of doubt
– Suspension of judgment (you don’t need your judgement, just wait until we have evidence)
 Withholding judgement until appropriate evidence is obtained
– Search for knowledge (you want to/ should look for more/ investigate)
 A desire to investigate beyond the obvious; with a desire to corroborate
– Interpersonal understanding (aware of that people have motivations, understand others might
have bias, info you get might not be correct)
 Recognition that people’s motivations and perceptions can lead them to provide biased
and misleading information
– Autonomy (= independent, you could make your decision, rather than accepting what others
say to you)
 The self-direction, moral independence and conviction to decide for oneself, rather than
accepting the claims of others
– Self-esteem (be confident in yourself/ the decision you made)
 The self-confidence to resist persuasion and to challenge assumption or conclusions

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Learning Objective 5.5
Describe the key elements of an effective professional
judgment process

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Professional Judgment
• Professional skepticism is one component of professional
judgment
• The profession has developed frameworks to assist
auditors in making appropriate judgments during an audit
to make them aware of their own judgment tendencies,
traps, and biases

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Figure 5.3 Elements of an Effective
Judgment Process
1 Identify and Define the issue

5 Review and document

2 Gather the information

3 Perform the analysis +

4 Make decision Identify the alternatives

Source: Professional Judgment Resource, provided courtesy of the Center for

Audit Quality (2014).

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Potential Judgment Tendencies,
Traps, and Biases (4 issues)
• Auditors should be alert for the following potential
judgment tendencies, traps, and biases that may
impact their decision-making process:
– Confirmation
– Overconfidence
– Anchoring
– Availability

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Table 5.1 Strategies to Mitigate Common Judgment
Tendencies (4 definitions)
Strategy to Avoid or Mitigate
Judgment Tendency
Tendency
Confirmation: The tendency to put more weight on • Make the opposing case and
information that is consistent with initial beliefs or consider alternative
preferences explanations
• Consider potentially
 We tend to listen/accept those info that is consistent with disconfirming or conflicting
what we decided, those inconsistent we would filter them = information
Confirmation bias (focusing you gathering info_
Overconfidence: The tendency to overestimate one’s own • Challenge opinions and
abilities to perform tasks or to make accurate assessments experts
• Challenge underlying
of risks or other judgments and decisions
assumptions
 Overestimate your ability to perform tasks
Anchoring: The tendency to make assessments by starting • Solicit input from others
from an initial value and then adjusting insufficiently away • Consider management bias,
from that initial value including the potential for fraud
 Once you made decision, it is difficult to change your or material misstatements
decision (Focusing you make/change decision)
Availability: The tendency to consider information that is easily • Consider why something
retrievable or easily accessible as being more likely or more comes to mind
• Obtain and consider objective
relevant
data
 We prefer info that you can get easily • Consult with others and make
the opposing case
Source: Professional Judgment Resource, Provided courtesy of the Center for Audit Quality
(2014). Copyright © 2020 Pearson Education Ltd. All Rights Reserved.
Let’s Discuss (2 of 6)
• Distinguish between management’s and the auditor’s
responsibility for the financial statements being audited.
• What is the auditor’s responsibility when noncompliance
with laws or regulations is identified or suspected?
– Need to obtain understanding + Evaluate the impact of
that non-compliance

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Let’s Discuss (3 of 6)
• What are the six elements of professional skepticism?
– Describe two of those six elements.
• Describe two of the more common judgment traps and
biases.

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Learning Objective 5.6
Identify the benefits of a cycle approach to segmenting the
audit

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Financial Statement Cycles
• Audits are performed by dividing the financial statements
into smaller segments or components (= cycles)
• The division makes the audit more manageable and aids
in the assignment of tasks to different members of the
audit team
• A common way to divide an audit is to keep closely related
types (or classes) of transactions and account balances in
the same segment

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Figure 5.4 Transaction Flow from
Journals to Financial Statements

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Relationships Among Cycles
• Transaction cycles are an important way to organize audits
• 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

– Each cycle is independent/ separate

– Cycles are interrelated

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Figure 5.6 Relationships Among Transaction Cycles
• Sales and collection cycle: related to Cash
• General Cash: all related except inventory
• Capital acquisition and repayment cycle: How the company get
investment, e.g. issuing shares/ borrowing money
• Payroll and personnel cycle: pay salary
• Acquisition and payment cycle: purchasing and making payments
• Inventory and warehousing cycle: purchasing inventory

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Learning Objective 5.7
Describe why the auditor obtains assurance by auditing
transactions and ending balances, including presentation
and disclosure

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Setting Audit Objectives
• 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
• Audit objectives include:
– Transaction-related audit objectives
 Transaction = what happen during the year
– Balance-related audit objectives
 Balance = Ending balance
 Since beginning balance been audited, we assume it is
correct
• Large audits  difficult to check everything
– Usual practice: a mix of testing transactions/ ending balances

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Figure 5.7 Balances and Transactions Affecting
Those Balances for Accounts Receivable

How do we check this number?

- Focus on ending balance for someone
we can share that talks outstanding
We care most about the ending balance receivables on that date
- Focus on what happened/ transactions
(since this figure would be displayed on F/S)
during the year

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Learning Objective 5.8
Distinguish among the management assertions about
financial information

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Management Assertions
• Management assertions are implied or expressed
representations by management about:
– Classes of transactions and the related accounts and
disclosures in the financial statements and
– They are directly related to the financial reporting
framework used by the company

– What management telling you through F/S or some

facts (e.g. sales are real) = Management assertions

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PCAOB Assertions (Skip)
• The PCAOB describes five categories of management
assertions:
– Existence or occurrence
– Completeness
– Valuation or allocation
– Rights and obligations
– Presentation and disclosure

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International and AICPA Assertions
• International auditing standards and AICPA auditing
standards further divide management assertions into
two categories: (2 types of assertions)
– Assertions about classes of transactions and events
and related disclosures for the period under audit
– Assertions about account balances and related
disclosures at period end

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Exam use this!
Table 5-3 Management Assertions for Each Category of Assertions

Exam don’t need to recite

the accurate words from
this table

Only keywords + refer to

the video what she
explained

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Assertions Lead to Audit Objectives
• Auditors may use different terms to express the management
assertions
– They should consider the relevance of each assertion for each
significant class of transactions and account balance
• Relevant assertions have a meaningful bearing on whether the
account is fairly stated and are used to assess the risk of material
misstatement and the design and performance of audit procedures

• Management assertions would become our audit objectives

–  What they told you then you would go to check/ verify
– Assertions = management assertions = audit objectives

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Let’s Discuss (4 of 6)
• Identify the cycle to which each of the following general ledger accounts will ordinarily
be assigned:
– sales, accounts payable, retained earnings, accounts receivable, inventory, and
repairs and maintenance.
 Sales and collection cycle: Sales, accounts receivable
 Acquisition and payment cycle: Accounts payable
 Capital acquisition and repayment cycle: : Retained earnings
 Inventory and warehousing cycle: Inventory
 Payroll and personnel cycle: Repairs and maintenance

• Distinguish between the general audit objectives and management assertions. Audit
objectives are derived from management assertions.
– Why are the general audit objectives more useful to auditors?
– In HK, management assertions = audit objectives.
– Textbook more audit objectives in 5.9

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Learning Objective 5.9
Link transaction-related audit objectives to management
assertions for classes of transactions

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Transaction-Related Audit Objectives (1 of 3)

• Occurrence
– Recorded or disclosed transactions exist
• Completeness
– Existing transactions are recorded and disclosures are
included
• Accuracy
– Recorded transactions are stated at the correct
amounts and disclosures are appropriately measured
and described

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Transaction-Related Audit Objectives (2 of 3)
• Posting and Summarization  related to classification
– Recorded transactions are properly included in the
master files and are correctly summarized
• Classification
– Transactions Included in the client’s journals are
properly classified

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Transaction-Related Audit Objectives (3 of 3)

• Timing (Cut-off)
– Transactions are recorded on the correct dates
• Presentation
– Transactions are appropriately aggregated or
disaggregated and described, and disclosures are
relevant and understandable

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Learning Objective 5.10
Link balance-related audit objectives to management
assertions

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Table 5-4 Starkwood Group: Management Assertions and
Transaction-Related Audit Objectives Applied to Sales
Transactions

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Balance-Related Audit Objectives
(1 of 3)

• Existence
– Amounts included exist
• Completeness
– Existing amounts and related disclosures are included
• Accuracy
– Amounts included are stated at the correct amounts,
and disclosures are appropriately measured and
described

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Balance-Related Audit Objectives
(2 of 3)

• Cutoff
– Transactions near the balance sheet date are recorded
in the proper period
• Detail tie-in
– Details in the account balance agree with related
master file amounts, foot to the total in the account
balance, and agree with the total in the general ledger
• Realizable value (=valuation and allocation)
– Assets are included at the amounts estimated to be
realized
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Balance-Related Audit Objectives
(3 of 3)

• Classification
– Amounts included in the client’s listing are properly
classified
• Rights and obligations
– Assets are owned or controlled by the entity, and
liabilities are obligations of the entity
• Presentation
– Amounts are appropriately aggregated or
disaggregated and described, and disclosures are
relevant and understandable

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Table 5-5 Starkwood Group: Management Assertions and
Balance-Related Audit Objectives Applied to Inventory

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Learning Objective 5.11
Explain the relationship between audit objectives and the
accumulation of audit evidence

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How Audit Objectives Are Met
• Auditors follow the four phases of the audit process
to ensure that all required audit objectives are both
specified and met:
– Plan and design an audit approach (Phase I)
– Perform tests of controls and substantive tests of
transactions (Phase II)
– Perform substantive analytical procedures and tests of
details of balances (Phase III)
– Complete the audit and issue an audit report (Phase
IV)

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Figure 5.8 Four Phases of a Financial
Statement Audit

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Let’s Discuss (5 of 6)
• Describe what is meant by the cycle approach to auditing.
What are the advantages of dividing the audit into different
cycles?
– We divide the financial statements into smaller
segments of related accounts.
• Define what is meant by a management assertion about
financial statements.
– Describe how PCAOB assertions and assertions in
international and AICPA auditing standards are similar
and different (skip).

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Let’s Discuss (6 of 6)
• What are specific audit objectives (=assertions)?
– Explain their relationship to the general audit objectives (as
defined in Objective 5.1).
 To issue an opinion, whether f/s are good or not yet true and
fair
 If I meet the specific audit objectives  will meet the general
audit objectives as well
• Identify the four phases of the audit.
– What is the relationship of the four phases to the objective of the
audit of financial statements?
 Slide 51

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