This chapter covers management’s responsibility, auditor’s responsibility, management assertions, what is considered sufficient appropriate evidence and professional skepticism.
Objective of an Audit and Management Responsibilities
Auditor responsibility for Errors and Fraud
Auditor Responsibility for Illegal Acts
Professional Skepticism and Professional Judgment in Auditing
AICPA Auditing Assertions
Benefit of Cycle Approach to Segmenting the Audit
Example: Management Assertions
It is management’s responsibility to adopt sound accounting policies, maintain adequate internal control, and make fair representations in the financial statements. The auditor’s responsibility is to conduct an audit of the financial statements in accordance with auditing standards and report the findings of the audit in the auditor’s report.
Auditing standards require that the audit be planned and performed with an attitude of professional skepticism in all aspects of the engagement, recognizing the possibility that a material misstatement could exist regardless of the auditor’s prior experience with the integrity and honesty of client management and those charged with governance. Professional skepticism consists of two primary components: a questioning mind and a critical assessment of audit evidence. A questioning mind means the auditor approaches the audit with a “trust but verify” mental outlook. A critical assessment of audit evidence includes asking probing questions and paying attention to inconsistencies.
The cycle approach is a method of dividing the audit such that closely related types of transactions and account balances are included in the same For example, sales, sales returns, and cash receipts transactions and the accounts receivable balance are all a part of the sales and collection cycle. The advantages of dividing the audit into different cycles are to divide the audit into more manageable parts, to assign tasks to different members of the audit team, and to keep closely related parts of the audit together.
Management assertions are implied or expressed representations by management about classes of transactions and the related accounts and disclosures in the financial statements. These assertions are part of the criteria management uses to record and disclose accounting information in financial
The PCAOB describes five categories of management assertions:
- Existence or occurrence−Assets or liabilities of the public company exist at a given date, and recorded transactions have occurred during the period.
Completeness−All transactions and accounts that should be presented in the financial statements are so included.
- Valuation or allocation−Assets, liability, equity, revenue, and expense components have been included in the financial statements at appropriate amounts.
- Rights and obligations−The public company holds or controls rights to the assets, and liabilities are obligations of the company at a given date.
- Presentation and disclosure−The components of the financial statements are properly classified, described, and disclosed.
The PCAOB provides for one set of assertions that apply to all financial statement information. These assertions are similar to the assertions in international and AICPA auditing standards, except that international and AICPA standards further divide management 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 presentation and disclosure
The objective of the audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which the financial statements present financial position, results of operations, and cash flows in conformity with applicable accounting standards.
The auditor meets that objective by accumulating sufficient appropriate evidence to determine whether management’s assertions regarding the financial statements are fairly stated.
An error is an unintentional misstatement of the financial statements. Fraud represents an intentional misstatement. The auditor is responsible for obtaining reasonable assurance that material misstatements in the financial statements are detected, whether those misstatements are due to fraud or error.
An audit must be designed to provide reasonable assurance of detecting material misstatements in the financial statements. Further, the audit must be planned and performed with an attitude of professional skepticism in all aspects of the engagement. Because there is an attempt at concealment of fraud, material misstatements due to fraud are usually more difficult to uncover than errors. The auditor’s best defense when material misstatements (either errors or fraud) are not uncovered in the audit is that the audit was conducted in accordance with auditing standards.
Misappropriation of assets represents the theft of assets by employees. Fraudulent financial reporting is the intentional misstatement of financial information by management or a theft of assets by management, which is covered up by misstating financial statements.
Misappropriation of assets ordinarily occurs either because of inadequate internal controls or a violation of existing controls. The best way to prevent theft of assets is through adequate internal controls that function effectively. Many times theft of assets is relatively small in dollar amounts and will have no effect on the fair presentation of financial statements, although there are some cases of material theft of assets. Fraudulent financial reporting is inherently difficult to uncover because it is possible for one or more members of management to override internal controls. In many cases the amounts are extremely large and may affect the fair presentation of financial statements.
The auditor should obtain sufficient appropriate evidence regarding material amounts and disclosures that are directly affected by laws and regulations. For example, the auditor should perform tests to identify if there have been any material violations of federal or state tax laws. The auditor should inquire of management and inspect correspondence with relevant licensing and regulatory agencies to identify instances of noncompliance with other laws and regulations that may have a material effect on the financial statements. During the audit, other audit procedures may bring instances of suspected noncompliance to the auditor’s attention. However, in the absence of identified or suspected noncompliance, the auditor is not required to perform additional audit procedures.
If the auditor becomes aware of information concerning an instance of noncompliance or suspected noncompliance with laws and regulations, the auditor should obtain an understanding of the nature and circumstances of the act. Additional information should be obtained to evaluate the possible effects on the financial statements. The auditor should also discuss the matter with management at a level above those involved with the suspected noncompliance and, when appropriate, those charged with governance. If management or those charged with governance are unable to provide sufficient information that
supports that the entity is in compliance with the laws and regulations, and the auditor believes the effect of the noncompliance may be material to the financial statements, the auditor should consider the need to obtain legal advice. The auditor should also evaluate the effects of the noncompliance on other aspects of the audit, including the auditor’s risk assessment and the reliability of other representations from management.
Academic research on the topic of professional skepticism suggests there are six characteristics of skepticism:
- Questioning mindset — a disposition to inquiry with some sense of doubt
- Suspension of judgment — withholding judgment until appropriate evidence is obtained
- Search for knowledge — a desire to investigate beyond the obvious, with a desire to corroborate
- Interpersonal understanding — recognition that people’s motivations and perceptions can lead them to provide biased or misleading information
- Autonomy — the self-direction, moral independence, and conviction to decide for oneself, rather than accepting the claims of others
- Self-esteem — the self-confidence to resist persuasion and to challenge assumptions or conclusions
Awareness of these six elements throughout the engagement can help auditors fulfill their responsibility to maintain an appropriate level of professional skepticism.