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Business Administration
BUS 426
Brad Bart

MODULE 3 AUDIT OBJECTIVES, EVIDENCE, PROCEDURES AND DOCUMENTATION AUDITOR’S RESPONSIBILITIES: Errors, irregularities, illegal acts There are audit standards from several sources that set out the auditor’s responsibilities for errors, irregularities and illegal acts. The CICA Handbook lists a number of rigorous auditing standards. These include standards concerning: • Misstatements – CAS 240 (Sect. 5135) • Misstatements due to illegal acts by clients – CAS 250 (Sect. 5136) • Auditing accounting estimates – CAS 540 (Sect. 5305) • Communication with those having responsibility for financial reporting – CAS 240 & CAS 260 (Sect. 5135 & 5751) • Communication of matters identified during the financial statement audit – various sections of CAS (Sect. 5750) Auditor’s Responsibility to Consider Fraud and Error in Audit of Financial Statements Since Enron, standards have been revised and require the auditor to make enquiries of management about fraud and to consider fraud risk factors on every audit engagement. The traditional assumption on management’s honesty was removed. CAS 240.04 “The primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. It is important that management, with the oversight of those charged with governance, place a strong emphasis on fraud prevention, which may reduce opportunities for fraud to take place, and fraud deterrence, which could persuade individuals not to commit fraud because of the likelihood of detection and punishment. ACCT4570 WINTER 2013 ROBERTSON Page 1 This involves a commitment to creating a culture of honesty and ethical behavior which can be reinforced by an active oversight by those charged with governance. Oversight by those charged with governance includes considering the potential for override of controls or other inappropriate influence over the financial reporting process, such as efforts by management to manage earnings in order to influence the perceptions of analysts as to the entity's performance and profitability. Responsibilities of the Auditor CAS 240.05. An auditor conducting an audit in accordance with CASs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the CASs. “ The auditor should assess inherent risk [the probability that material misstatements have occurred] and control risks [the risk that the client’s internal control will not prevent or detect a material misstatement] so that, together with the substantive tests [the performance of procedures to obtain direct evidence to produce evidence about the dollar amounts and disclosures in the financial statements] performed, the risk of material misstatement from fraud and error is appropriately low. Another important requirement is obtaining written representations from management concerning the non-existence or extent of fraud. The appendices to CAS 240 (Sect. 5135) contain numerous examples of situations that indicate the possibility of fraud. Further to the requirements set out in CAS 240.12 (Sect. 5135, Sect. 5090. 05) states that “In accordance with CAS 200, the auditor shall maintain professional skepticism throughout the audit, recognizing the possibility that a material misstatement due to fraud could exist, ACCT4570 WINTER 2013 ROBERTSON Page 2 notwithstanding the auditor's past experience of the honesty and integrity of the entity's management and those charged with governance. (Ref: Para. A7-A8)” & CAS 200.15 states “The auditor shall plan and perform an audit with professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated. (Ref: Para. A18-A22) In other words, there is no valid excuse for an auditor to omit the consideration of potential material misstatements when planning an audit. Illegal Acts by Clients Responsibility of Management CAS 250.03 “It is the responsibility of management, with the oversight of those charged with governance, to ensure that the entity's operations are conducted in accordance with the provisions of laws and regulations, including compliance with the provisions of laws and regulations that determine the reported amounts and disclosures in an entity's financial statements.” Responsibility of the Auditor CAS.04 “The requirements in this CAS are designed to assist the auditor in identifying material misstatement of the financial statements due to non-compliance with laws and regulations. However, the auditor is not responsible for preventing non-compliance and cannot be expected to detect non-compliance with all laws and regulations.” CAS.05 “The auditor is responsible for obtaining reasonable assurance that the financial statements, taken as a whole, are free from material misstatement, whether caused by fraud or error. In conducting an audit of financial statements, the auditor takes into account the applicable legal and regulatory framework. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements in the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the CASs. In the context of laws and regulations, the ACCT4570 WINTER 2013 ROBERTSON Page 3 potential effects of inherent limitations on the auditor's ability to detect material misstatements are greater for such reasons as the following: • There are many laws and regulations, relating principally to the operating aspects of an entity, that typically do not affect the financial statements and are not captured by the entity's information systems relevant to financial reporting. • Non-compliance may involve conduct designed to conceal it, such as collusion, forgery, deliberate failure to record transactions, management override of controls or intentional misrepresentations being made to the auditor. • Whether an act constitutes non-compliance is ultimately a matter for legal determination by a court of law. Ordinarily, the further removed non-compliance is from the events and transactions reflected in the financial statements, the less likely the auditor is to become aware of it or to recognize the non-compliance.” Auditing Accounting Estimates There have been numerous fraud cases based on the use of intentionally incorrect accounting estimates. By their nature, accounting estimates are subject to some degree of inexactness. The auditor, however, is responsible for determining the reasonableness of management’s accounting estimates in the context of the financial statements. There are a number of recommendations in the CICA Handbook in this area and they need to be taken under consideration when planning and performing the audit. CAS 540.06 (Sect. 5306.04) “The objective of the auditor is to obtain sufficient appropriate audit evidence about whether: (a) accounting estimates, including fair value accounting estimates, in the financial statements, whether recognized or disclosed, are reasonable; and (b) related disclosures in the financial statements are adequate, ACCT4570 WINTER 2013 ROBERTSON Page 4 in the context of the applicable financial reporting framework. OBJECTIVE OF AN AUDITOR UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT AND ASSESSING THE RISKS OF MATERIAL MISSTATEMENT CAS 315.03 (paragraph 5141.022,) “The objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels, through understanding the entity and its environment, including the entity's internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement.” Communication with Audit Committees During the course of an audit, the auditor may become aware of matters that should be brought to that attention of the audit committee. Matters such as significant weaknesses in the system of internal control, misstatements (other than trivial matters), fraud, misstatements that may cause future financial statements to be materially misstated or illegal or possibly illegal acts, other than ones considered inconsequential. In various CAS sections (Sect. 5750) the Handbook sets out the content for the communications, the timing of the communications and the documentation for the communications. Auditor’s Ranking of the Relative Importance of Fraud Warning Signs 1. Managers have lied to the auditors or have been overly evasive in response to audit enquiries. 2. The auditor's experience with management indicates a degree of dishonesty. 3. Management places undue emphasis on meeting earnings projections or the quantitative targets. ACCT4570 WINTER 2013 ROBERTSON Page 5 4. Management has engaged in frequent disputes with auditors, particularly about aggressive application of accounting principles that increase earnings. 5. The client has engaged in opinion shopping. 6. Management's attitude toward financial reporting is unduly aggressive. 7. The client has a weak control environment. 8. A substantial portion of management compensation depends on meeting quantified targets. 9. Management displays significant disrespect for regulatory bodies. 10. Management operating and financial decisions are dominated by a single person or a few persons acting in concert. 11. Client managers display a hostile attitude toward the auditors. 12. Management displays a propensity to take undue risks. 13. There are frequent and significant difficult-to-audit transactions. 14. Key managers are considered highly unreasonable. 15. The client's organization is decentralized without adequate monitoring. 5 Assertions: Specific Audit Objectives The overall objective of an audit of financial statements to express an opinion whether the financial statements present fairly, in all material respects, the financial position, results of operation and changes in financial position in accordance with generally accepted accounting principles. Management is responsible for the financial statements and accordingly, they make assertions about their correctness. As an auditor, we obtain and evaluate evidence about the assertions made by management in those financial statements. Auditors examine five main assertions that support the financial statements. The auditor’s ACCT4570 WINTER 2013 ROBERTSON Page 6 audit objectives can therefore be analyzed in specific financial statement areas based on these five assertions: 5-6 ASSERTIONS 1.Existence – establish with evidence that assets, liabilities and equities actually exist and revenue and expense transactions actually occurred. 2.Completeness – establish with evidence that all transactions that should be presented in the financial statements are included. 3.Ownership – establish with evidence that amounts reported as the assets of the company represent its property rights and that the amounts reported as liabilities represent its obligations. 4.Valuation – determine whether proper values have been assigned to assets, liabilities, equities, revenue and expense. 5.Presentation – determine whether accounting principles are properly selected and applied, whether information is presented in accordance with underlying economic reality, whether disclosures are adequate, and whether any GAAP that apply have been followed. 6.Compliance – determine whether corporation has complied with appropriate laws and regulations. Audit Evidence CAS 500.06 (CICA Handbook Sect. 5300.) (Chapter 8 Pages 288 – 291) “The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence. (Ref: Para. A1-A25)” Bookkeeping records, in isolation, do not provide adequate evidence to support the financial statements. The auditor is required to gather evidence to support the financial statements through the auditor’s direct personal knowledge, examination of documents and the enquiry of company personnel. The auditor must use critical thinking skills and obtain evidence appropriate to support the audit opinion. ACCT4570 WINTER 2013 ROBERTSON Page 7 Appropriateness of Evidence It is not sufficien
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