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chapter six we start the audit process and we're going to specifically talk about the audit responsibilities and the objectives so the steps to develop the objectives are that we've got to understand the objectives and the responsibilities for each audit that the companies are undertaking they then need to divide the financial statements into different Cycles they need to understand Management's assertions about those accounts and then um know the general out of audit objective for each class of transaction and account so like we'll get into more details on that but is it a sales transaction does it create an accounts receivable so how do we how do we audit sales and then how do we audit that balance that's in the accounts receivable account so that's an example um and then know the specific audit objectives for the class of transactions accounts and disclosures so I can add disclosures to that as well um so those are the things that that that are the steps to develop the audit so the first step um is to identify again um what we're doing so we're our goal of an audit is to issue that opinion regarding the presentation of the financial statement so are they are the financial statements free of any material misstatement um you know can we issue an unqualified or a clean report or unmodified report or do we have to have a um an example an explanatory paragraph or is there going to be a disclaimer or whatever so this that's our issue our our primary focus is to prepare the audit report that issues a statement regarding the presentation of those financial statements um so they need to obviously use do care and exercise professional judgment and follow their generally accepted Accounting Standards again taking that back to chapter five that's their defense that you know they'll have no lawsuits no one could come after them because they did everything correct so then what is the client's responsibility versus the auditor's responsibility so the client's responsibility is for actually preparing the financial statements and then the auditor's responsibility is basically just verifying that those statements are providing reasonable assurance that those statements are free from any material misstatement and that you know they they can be you know they they represent the company to without again they're not they're not making a guarantee that everything's 100 accurate just providing the reasonable assurance that these financial statements can be relied upon so again the client's responsibilities um the CFO or the CEO are going to sign off on those statements they also sign off that they've established and maintained effective internal controls you know to support their accounting processes and then the auditor's responsibility will then be to communicate their opinion on their um on their audit report so then we when we're focused on what is the auditor's responsibility you know they're responsible for discovering any material misstatements that may happen due to fraud or error so that is the responsibility of the auditor so then materiality comes into play there again because they were responsible for discovering material misstatements so a minor misstatement is not going to be anything to raise the red flag about it would have to be material and that goes back to each audit individually and then the real key is would it influence a reasonable decision a reasonable user's decision on those financial statements so maybe a bank to give a loan or a stockholder to buy stock so if it's something very small in comparison to their dollar amount of assets it's going to be immaterial um so so materiality always comes into play but again is unique to the to the audit that you're on um so again the reasonable Assurance is not a guarantee we've said that like in probably almost all of our chapters so far um and the reason we can't guarantee anything is all we're really doing is taking samples when we're performing our audit tests a lot of times there's very complex estimates that are in people's in in the client's financial statements and the audit managers can talk to the clients and figure out how those were calculated and make sure they're comfortable with how they prepared those estimates but there's still estimates um and then if you have um think of like Enron where you have top level people who are involved in in creating some sort of a of a fraudulent scam it's going to be harder for the Auditors to find those because they're going to definitely cleverly conceal them because they don't want to get caught um so then we talk about again error and fraud are two types so error is when it's just an unintentional mistake or an omission of a of an entry or a transaction or an account or something like that so it wasn't on purpose we're not they're not trying to defraud anybody but a fraudulent one would be an intentional misappropriation of assets or a fraudulent financial reporting so misappropriation of assets is somebody is stealing something so maybe they're taking cash deposits maybe they're stealing and selling inventory fraudulent reporting is is when they're um you know kind of more like I guess I mean Enron also they they might have been taking money too but but but they definitely were fraudulent reporting their financial statements so so they their users thought that they had more income and they had more assets and Equity than they actually did so their overstating income or they're overstating ass assets or showing that they have um more Equity than they really do all of those would be um examples of fraudulent reporting and then there could also be illegal acts so we have direct effect legal acts and indirect effect legal acts so direct effect legal acts have a direct Financial impact on the company um and then a indirect effect illegal act would not have direct impact on the expenses or the payables of the financial statements but if caught or you know prosecuted they could have fines so an example of that would be like they're breaking environmental laws so they're they're dumping toxins into Lake Erie and if they get caught you uncover that and they get caught you know that they could end up with fines and obviously a lot of bad publicity Auditors are not there to look for illegal acts it's not like they were working for the FBI and we're trying to uncover that stuff however when they review the minutes of the board of directors or they always reach out to attorneys and add and send the attorneys a questionnaire at the end of the audit to see what's out there when they're fishing like that they might find some information that could expose some illegal activities so if those are identified in like that litigation inquiry inquiry their responsibility is to disclose whatever they find out and communicate it to the board of directors and or the audit committee so all the attitudes we've we've talked about these in our past chapters as well but anytime we're dealing with an audit these are two of the Prime um characteristics or attitudes that the Auditors need to maintain so they need to exercise professional skepticism where they basically kind of look at everything with a questioning mind and kind of critically assess it so you you talk to the client and you you hear what they say so you trust them but you still go through the actual effort to verify it just because they tell you they took a physical account of inventory and this is the balance you don't just go okay great I'll use that you actually go and you're a part of that physical inventory count you go and randomly you know test different items and verify the count sheets and and see that they're following the proper internal control procedures and that type of stuff so the elements of that is that you have to have a questioning mindset set you have to be um suspend suspend your judgment um so again that could be that could be positive or negative I mean say you think oh no no I think they're great and they're doing everything right that would be um you know in a sense of judgment that you're saying um that you know I mean you've you've already made your decision or whatever based or or it could be negative um search for knowledge which would happen again through our audit testing um interpersonal understanding and um autonomy so again always keeping your Independence and then self-esteem so those are characteristics of um professional skepticism and the self-esteem let me just to clarify that a little bit is to just resist persuasion and to challenge assumptions um because again think about many times who your audit people are they're right out of college so I mean they might be talking to a guy who's been doing you know working at this company as the controller for 25 years and you're you know you're 25 and right out of college so you still have to have that kind of that self-confidence that says I'm not gonna like you know just listen to this this client just because he's been here so long and he's you know talking in a very authoritative voice you still gotta challenge those assumptions and and you know do your job okay then professional judgment um so professional skepticism is a component of professional judgment um so professional judgment is identifying what the issue is gathering relevant information identifying if there's potential Alternatives make a decision and then complete your documentation and your rationale for your conclusion so um your judgment Tendencies would be that um you could have confirmation where you've already decided like you've already thought hey um I think this place is very trustworthy and they make good decisions and then you know you you ask a few questions to the audit me or to the clients management and you're you're confirming that and thinking okay um my initial belief was that they were good and now I've confirmed it I'm moving on overconfidence is the tendency to overestimate your ability um or make accurate risks accurate assessments about the risk so you always got to kind of challenge every opinion and challenge underlying assumptions kind of again keep that professional skepticism um in in your work ethic um anchoring is the tendency to make an assessment by starting with that initial value and then adjusting it um [Music] insufficiently um so what you really should do to avoid that is to solicit input from other people um consider if there's any management bias or or potential for fraud um so again it's kind of more like keeping that open mind and then availability is um the content the tendency to consider information that is easily available or easily accessible but sometimes you know the clients are counting on that so then that's going to be information that's going to you know obviously not if they're trying to cover something it's going to be the the information they want you to get so so sometimes you have to go a little further um and consult with others and and you know kind of um consider some objective data and and to to go a little deeper into the the documentation all right um then our next step gets into our different financial statement Cycles so um we have the cycle approach to segmenting the audit so we're going to keep all of our related accounts and activities kind of in that same segment so we have our sales and our collection Cycles so billing out customers looking at the accounts receivable balance we have the acquisition and payment cycle so our accounts payable department we get invoices in and how often do we pay them and our accounts payable account payroll and Personnel so obviously cutting paychecks looking at Time Records our inventory cycle which could involve purchasing inventory but it's probably more how do we maintain the inventory how do we issue it out to the jobs um then how do we charge it off when it's sold and then our Capital acquisition and our payment cycle there as well so that's going to be more of um you know like our long-term capital assets how do we maintain those do we you know some companies will have little um like like serial numbers that go with every fixed asset so they know when they dispose of one to take it off the books all that kind of stuff or a new one comes in how do they set that up and then there's there's transaction related objectives and then there's balance related objectives so transactions are things that like like recording a sales invoice or entering an accounts payable invoice or transferring inventory to to a job those are all like transactions the balance related things are like well what what's in my accounts receivable balance at the end of the year which relates to those invoices that we send to customers but what's what's left at the end of the year in that balance what's left in our inventory account after we've transferred stuff to jobs what's in our accounts payable to account you know that type of thing then our step three is our management assertions so the criteria management uses to record information so existence so is it it does is it actually real you know just because they have all these fixed assets on their books do they legitimately exist or could some of them be fictitious because some of them have been added could some have been sold and not removed from the ledger so do they physically exist or if it's like more of a transactional thing did it actually occur did that sale that that we see an invoice for did it really happen um completeness is that all of the transactions um that should be presented in those financial statements are there so if we're looking at them as of December 31st is everything included in there um again because there could be maybe issues with their cut off process that some items are missing maybe it's intentional they didn't put something on the books um then we have valuation and allocation so again looking at our financial statements our assets our liabilities our revenues our expenses are all of those in at the proper amounts and in our financial statements accurate um so then I have in parentheses here like you know consider even the estimates that we use for assets and depreciation um or valuing inventory all of those things kind of would go into that category um rights and obligations you know do they really hold the right to the assets and the and and the liabilities on their balance sheet date so that's what makes it you know date specific because we're looking at our assets and our liabilities so on the balance sheet date do we did we really own it and have title to it um or did we have the loan in our names and then presentation and disclosure is that the financial statements are properly classified and described and disclosed so the Auditors are going to go through and they're going to test all of those things they'll again they'll look at um transactional audits to make sure that um all item is all items that should be included are and then they're going to look at the balances on different accounts so are they at the correct values and are they in the correct classification current assets long-term assets current liabilities long-term liabilities all that type of stuff like to our financial statements um then we get into our transaction related audit objectives um so we have occurrence again that it actually occurred completeness that all the transactions that should be recorded are recorded accuracy that they're at their correct amounts posting and summarization like as you read through the textbook like in an image you work in the work world that all happens within your it program so depending on what type of software you're using that's happening behind the scenes so the Auditors just have to get comfortable with that programming that everything's correct you know maybe do some testing maybe talk to the I.T people whatever gets them comfortable but then once they know that that's all happening accurately they can just rely on that information um classification that things are posted to the appropriate accounts and that they're at the correct dates a timing element and then presentation so that they are appropriately aggregated and if they're making disclosures that or if they need to make disclosures that those are made and those are relevant so again time kind of back to our complete financial statements so balance related versus I think transactional related is what we're going to have on the next slide so balance related audit objectives so those are like okay I'm looking at accounts receivable and I want to know is my accounts receivable balance it's on my balance sheet um accurate and how can I get comfortable that it is so these would be the types of um things that they're going to to look at so um they're going to have the same that I that I mentioned previously existence completeness accuracy classification and presentation and then disclosure so those are on the last slide but in addition um we're going to look at cutoff testing so is it recorded in the proper period so inventory is a really really hot one on that standpoint what is their policy for what do they include in inventory like it was it shipped out today and was it Freight on board or um was it Freight on board shipping or destination you know some of those different unique scenarios where maybe it's Freight on board shipping point so then it shouldn't be included in our inventory because it left today but if it's Freight on board destination and it's still in route it should be on our inventory um so those are very unique kind of scenarios or what if we have consignment stuff that should be in there or not in there um but that doesn't kind of go into cutoff testing so cutoff testing is more that timing to say okay if I'm taking inventory on this day I need to make sure everything that should be in inventory I've counted and I've recorded properly or everything that should be in my accounts receivable well what about checks in the mail those kind of scenarios um then you can have detailed tie-in where you take a specific transaction such as like a sales invoice and you tie it back into the account detail and then you take that account detail and TR and um Trace that into the ledger balance so accounts receivable take one customer's invoice into the accounts receivable sub Ledger then take that that customer's total into the total accounts receivable balance and then take that all the way into the you know the trial balance um realizable value that assets are included at their true amounts so that if you have any obsolete inventory that's been written off if you're looking through your accounts receivable have you done a proper bad debt analysis to write off the people who haven't paid and it's been over 90 days and you've done all kinds of things to collect um the rights and obligations would look at your assets owned or your liabilities owed so maybe even you know you're going to test some of those documents to make sure you had legal rights to that asset again on the balance sheet date so then the phases of the audit process we're going to plan and just design the audit approach and within that audit approach we need to make sure that we are getting um the right amount of evidence and that um again because you know you could say well the more evidence I get the better but then you have to also look at the cost of gathering that evidence so you want to kind of you know maximize get the most out of your evidence with the minimum cost so looking at your materiality levels looking at what accounts you should look at and then what do you got to pull so in order to do all that stuff you do have to understand the business understand their internal controls and what level of risk it is the higher the risk obviously probably the more evidence we're going to have to pull um then we're going to actually perform our test of controls to understand again that internal control structure which again helps us to assess our level of risk um we're going to perform analytical procedures and test of details of balances so our analytical procedures um consist of like looking at the financial information and then just kind of um you know get comfortable with that account balance so we've got um you know like an example would be like if we're looking at our sales transactions and our accounts receivable the audit the auditor is going to look at a sales journal for any unusually large amounts compare those to the monthly sales um you know just kind of make sure that everything seems reasonable then there's going to be a test of the um um attest to the detail of the balances so then those are going to be where you're actually physically looking at something on the financial statements such as accounts receivable and with the like with accounts receivable you can do third party confirmations so you can again take your highest customers the customers that have that the most owed to the to the client and actually confirm those and send them a letter it says Hey as of the end of the year these are the invoices that we think are outstanding with this with our client please confirm and that's the best way to do it because then you have an outside third party confirming what they're showing on their books and then you're going to obviously complete the audit and issue an opinion about those financial statements again it's that overall conclusion whether the financial statements are fairly presented and that's always based on your professional judgment again never a guarantee so that is our audit process kind of going through the audit responsibilities and the objectives thank you