AUD 589

AUDITING 1

Scope of Financial Statements

Audit

Prepared by:
Yusarina Mat Isa
UiTM Kampus Puncak Alam
 Learning Objectives
• Able to:
 Explain the scope financial statement audit
 Explain management assertions and audit objectives

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Scope of Financial Statement Audit
Understand objectives and
responsibilities for the audit √ Done!
Divide financial statements into cycles

Know management assertions about

accounts

Know general audit objectives for classes

of transactions and accounts

Know specific audit objectives for classes

of transactions and accounts

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 Cycles of Financial Statements
• Sales and collection cycle
• Acquisition and payment cycle
• Payroll and personnel cycle
• Inventory and warehousing cycle
• Capital acquisition and repayment cycle

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 Management Assertions

• Management is responsible for ensuring that the

financial statements give true and fair view in
accordance with the applicable financial reporting
framework
• Management makes various explicit and implicit
assertions about the elements of those financial
statements
• These assertions are management’s representation
relating to the recognition and measurement of the
various items and components in the financial
statements
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Management Assertions (cont.)
• Existence E
• Occurrence O
• Rights and obligations R
• Completeness C
• Valuation or allocation V
• Measurement M
• Presentation and disclosure P

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Management Assertions (cont.)
• Existence: the assets and liabilities exist at a given date
– E.g. management asserts that inventory shown on the balance sheet
physically exists and is available for sale

• Rights and obligations: the assets are rights of the entity, and
the liabilities are its obligation
– E.g. management asserts that the entity has legal rights of ownership
to the inventory shown in the balance sheet
– E.g. amount capitalizes for leases reflect assertions that the entity has
rights to leased property and that the corresponding lease liability
represents an obligation of the entity

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Management Assertions (cont.)
• Occurrence: a transaction or event has taken place
– E.g. management asserts that revenues reported in the
income statement represent valid sales that occurred
during the period

• Completeness: the accounts and transactions that

should be included are included; thus the financial
statements are complete
– E.g. management asserts that inventory represents all
items on hand at the balance sheet date
– Management also implicitly asserts that the amounts
payable on the balance sheet includes all such liabilities as
of the balance sheet date
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Management Assertions (cont.)
• Valuation: assets and liabilities are recorded at appropriate
carrying date
– E.g. management asserts that inventory carried at the lowest cost or
market value on the balance sheet

• Measurement: a transaction is recorded at the proper amount

and revenue or expenses is allocated to the proper accounting
period
– E.g. management asserts that the cost of property, plant and
equipment is systematically allocated to appropriate accounting period
by recognising depreciation charge

• Presentation and disclosure: amounts shown in the financial

statements are properly presented and disclosed
– E.g. management asserts that the portion of long term debt shown as
current liability will mature in the current year.
– E.g. management asserts through notes disclosure, that all major
restrictions on the entity resulting from debt convenants are disclosed 9
 Setting Audit Objectives
• Specific/general transaction- related audit
objectives
– E.g. sales, sales return

• Specific/general balance-related audit

objectives
– E.g. account receivables, account payable

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 Transaction-related Audit
Objectives
• Existence
• Completeness
• Accuracy
• Classification
• Timing
• Posting and summarization

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 Balance-related Audit Objectives
• Existence
• Completeness
• Accuracy
• Classification
• Cutoff
• Detail tie-in
• Realizable value
• Rights and obligations
• Presentation and disclosure

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 How Audit Objectives Are Met
• Plan and design an audit approach
– Obtain knowledge of the client’s business strategies and processes, and assess
risks involved
– Understand internal control and assess control risk
• Perform tests of controls and substantive test of transactions
• Perform analytical procedures and tests of details of balances
• Complete the audit and issue an audit report

• Auditor must obtain sufficient appropriate audit evidence to support all

management assertions in the financial statements.
• This is done by accumulating evidence in support of some appropriate
combination of transaction-related audit objectives and balance-related
audit objectives

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 How Audit Objectives Are Met
• Test of controls – auditor will test the effectiveness of
the controls.
(eg: client’s internal controls require the verification by an
independent clerk of all unit selling prices on sales before sales
invoices are mailed to customers)

• Subtantive tests of transactions – auditor evaluate the

client’s recording of transactions by verifying the
monetary amount of transactions.
(eg: auditor to compare the unit selling price on a duplicate sales invoice with
the approved price list as a test of the accuracy objectives for sales
transactions)

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 How Audit Objectives Are Met
• Analytical procedures – use comparisons and relationships to
assess whether account balances or other data appear
reasonable.
(eg: an analytical procedure that would provide some assurance for the
accuracy objective for both sales transactions and account receivables is to
examine sales transactions in the sales journal for unusually large amounts
and to compare total monthly sales with prior years. )

• Test of detail balances – test for monetary misstatements in the

balances in the financial statements.
(eg: related to the accuracy objective for accounts receivable is direct written
communication with the client’s customers. This test is essential to the
conduct of the audit because most of the evidence is obtained from a source
independent of the client and therefore considered to be of high quality)

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Relationships among Management’s Assertion, Audit
Objectives, Audit Procedures, and Audit Evidence

Management’s assertions are contained in the financial statements

Auditor develops audit objectives based on management’s assertions

Audit procedures are conducted to test the audit objectives

Audit Evidence is developed to support management’s assertions

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End of Topic 3a