Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
6
Part II
THE AUDIT PROCESS
(Chapters 6-12)
Part II presents the audit process in a
manner that will enable you to apply the
concepts developed in these
chapters to any audit area.
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
AUDIT
RESPONSIBILITIES
AND OBJECTIVES
Audit Objective
Primary objective of the audit
is to express an opinion on the
financial statements
Other objectives are secondary
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
FIGURE 6-1 Steps to Develop Audit Objectives
Understand objectives
and responsibilities
for the audit
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
1
2
3
4
5
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Management vs,Auditor
Responsibilities
Management
Financial statement
Internal controls
Auditor
Issue opinion on fairness of
F/S’s
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Issue Opinion on Financial Statement
Other objectives are secondary
Provides reasonable assurance financial
statement are free from material misstatement
Audit performed with professional skepticism
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
CATEGORY 1
Management’s Characteristics
and Influence over the
Control Environment
These pertain to management’s
abilities,pressures,style,and attitude
relating to internal control and the
financial reporting process.
CATEGORY 2
Industry Conditions
These involve the economic and
regulatory environment in which the
entity operates.
CATEGORY 3
Operating Characteristics
and Financial Stability
These pertain to the nature and complexity of
the entity and its transactions,financial
condition,and profitability
Examples of Risk Factors
A motivation for management to
engage in fraudulent financial
reporting,such as an excessive interest
by management to maintain or increase
the entity’s stock price or earnings
trend through the use of unusually
aggressive accounting practices.
A failure by management to display
and communicate an appropriate
attitude regarding internal control and
the financial reporting process,such as
domination of management by a single
person or small group without
compensating controls.
High turnover of senior management,
counsel,or board members.
Examples of Risk Factors
New accounting,statutory,or
regulatory requirements that could
impair the financial stability or
profitability of the entity.
Declining industry with increasing
business failures and significant
declines in customer demand.
Rapid changes in the industry,such
as high vulnerability to rapidly
changing technology or rapid product
obsolescence.
Examples of Risk Factors
Significant pressure to obtain
additional capital necessary to stay
competitive considering the financial
position of the entity.
Significant,unusual,or highly
complex transactions,especially those
close to yearend,that pose difficult
“substance over form” questions.
Overly complex organizational
structure involving numerous or
unusual legal entities,managerial lines
of authority,or contractual
arrangements without apparent
business purpose.
TABLE 6-1 The Three SAS 82 Categories of Risk Factors for Fraudulent Financial Reporting & Three Examples of Each
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
TABLE 6-2 The Two SAS 82 Categories of Risk Factors for Misappropriation
of Assets and Two Examples of Each
CATEGORY 1
Susceptibility of Assets
to Misappropriation
These pertain to the nature of an entity’s assets
and the degree to which they are subject to theft.
CATEGORY 2
Controls
These involve the lack of controls designed to
prevent or detect misappropriations of assets.
Examples of Risk Factors
Large amounts of cash on hand or processed
Easily convertible assets,such as bearer
bonds,diamonds,or computer chips
Fixed asset characteristics,such as small
size,marketability,or lack of ownership
identification
Examples of Risk Factors
Lack of appropriate management oversight
such as inadequate supervision or monitoring
of remote locations
Inadequate record keeping with respect to
assets susceptible to misappropriation
Lack of timely and appropriate documentation
for transactions,such as credits for merchandise
returns
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Responsibilities for
Discovering Illegal Acts
Direct-Effect Illegal Acts (same as errors & irregs)
Indirect-Effect Illegal Acts (No assurance)
Evidence Accumulation When There is No Reason to
Believe Indirect-Effect Illegal Acts exist (no resp.)
Evidence Accumulation and Other Actions When There is
Reason to Believe Direct - or Indirect-Effect Illegal Acts
May Exist (inquire,consult,consider more evidence)
Actions when the Auditor Knows of an Illegal Act (consider f/s
Effect,BOD’s/Audit Cte.,collect sufficient evidence)
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Sales SalesJournal
Cash Receipts CashReceipts Journal
Acquisition of
Goods & Services
Acquisition
Journal
Cash
Disbursements
Cash
Disbursements
Journal
Payroll Services
& Disbursements Payroll Journal
Allocation and
Adjustments General Journal
General Ledger
and Subsidiary
Records
General Ledger
Trial Balance
Financial
Statements
TRANSACTIONS JOURNALS LEDGERS,TRIAL BALANCES,
AND FINANCIAL STATEMENTS
FIGURE 6-3
The Cycle Approach to segmenting an audit
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
FIGURE 6-5 Relationships among Transaction Cycles
General
Cash
Capital Acquisition
and Repayment Cycle
Sales and
Collection
Cycle
Inventory and
Warehousing
Cycle
Acquisition and
Payment
Cycle
Payroll and
Personnel
Cycle
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
SETTING AUDIT OBJECTIVES
Figure 6-6 Balance and Transactions Affecting Those Balances
for Accounts Receivable
Accounts Receivable
Beginning balance $ 96
$660Sales
Ending balance $105
$590
$ 26
$ 35
Cash receipts
Sales returns
and allowances
Charge-off of
uncollectible
accounts
2000 Prentice Hall,Inc.
6
Part II
THE AUDIT PROCESS
(Chapters 6-12)
Part II presents the audit process in a
manner that will enable you to apply the
concepts developed in these
chapters to any audit area.
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
AUDIT
RESPONSIBILITIES
AND OBJECTIVES
Audit Objective
Primary objective of the audit
is to express an opinion on the
financial statements
Other objectives are secondary
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
FIGURE 6-1 Steps to Develop Audit Objectives
Understand objectives
and responsibilities
for the audit
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
1
2
3
4
5
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Management vs,Auditor
Responsibilities
Management
Financial statement
Internal controls
Auditor
Issue opinion on fairness of
F/S’s
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Issue Opinion on Financial Statement
Other objectives are secondary
Provides reasonable assurance financial
statement are free from material misstatement
Audit performed with professional skepticism
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
CATEGORY 1
Management’s Characteristics
and Influence over the
Control Environment
These pertain to management’s
abilities,pressures,style,and attitude
relating to internal control and the
financial reporting process.
CATEGORY 2
Industry Conditions
These involve the economic and
regulatory environment in which the
entity operates.
CATEGORY 3
Operating Characteristics
and Financial Stability
These pertain to the nature and complexity of
the entity and its transactions,financial
condition,and profitability
Examples of Risk Factors
A motivation for management to
engage in fraudulent financial
reporting,such as an excessive interest
by management to maintain or increase
the entity’s stock price or earnings
trend through the use of unusually
aggressive accounting practices.
A failure by management to display
and communicate an appropriate
attitude regarding internal control and
the financial reporting process,such as
domination of management by a single
person or small group without
compensating controls.
High turnover of senior management,
counsel,or board members.
Examples of Risk Factors
New accounting,statutory,or
regulatory requirements that could
impair the financial stability or
profitability of the entity.
Declining industry with increasing
business failures and significant
declines in customer demand.
Rapid changes in the industry,such
as high vulnerability to rapidly
changing technology or rapid product
obsolescence.
Examples of Risk Factors
Significant pressure to obtain
additional capital necessary to stay
competitive considering the financial
position of the entity.
Significant,unusual,or highly
complex transactions,especially those
close to yearend,that pose difficult
“substance over form” questions.
Overly complex organizational
structure involving numerous or
unusual legal entities,managerial lines
of authority,or contractual
arrangements without apparent
business purpose.
TABLE 6-1 The Three SAS 82 Categories of Risk Factors for Fraudulent Financial Reporting & Three Examples of Each
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
TABLE 6-2 The Two SAS 82 Categories of Risk Factors for Misappropriation
of Assets and Two Examples of Each
CATEGORY 1
Susceptibility of Assets
to Misappropriation
These pertain to the nature of an entity’s assets
and the degree to which they are subject to theft.
CATEGORY 2
Controls
These involve the lack of controls designed to
prevent or detect misappropriations of assets.
Examples of Risk Factors
Large amounts of cash on hand or processed
Easily convertible assets,such as bearer
bonds,diamonds,or computer chips
Fixed asset characteristics,such as small
size,marketability,or lack of ownership
identification
Examples of Risk Factors
Lack of appropriate management oversight
such as inadequate supervision or monitoring
of remote locations
Inadequate record keeping with respect to
assets susceptible to misappropriation
Lack of timely and appropriate documentation
for transactions,such as credits for merchandise
returns
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Responsibilities for
Discovering Illegal Acts
Direct-Effect Illegal Acts (same as errors & irregs)
Indirect-Effect Illegal Acts (No assurance)
Evidence Accumulation When There is No Reason to
Believe Indirect-Effect Illegal Acts exist (no resp.)
Evidence Accumulation and Other Actions When There is
Reason to Believe Direct - or Indirect-Effect Illegal Acts
May Exist (inquire,consult,consider more evidence)
Actions when the Auditor Knows of an Illegal Act (consider f/s
Effect,BOD’s/Audit Cte.,collect sufficient evidence)
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
Sales SalesJournal
Cash Receipts CashReceipts Journal
Acquisition of
Goods & Services
Acquisition
Journal
Cash
Disbursements
Cash
Disbursements
Journal
Payroll Services
& Disbursements Payroll Journal
Allocation and
Adjustments General Journal
General Ledger
and Subsidiary
Records
General Ledger
Trial Balance
Financial
Statements
TRANSACTIONS JOURNALS LEDGERS,TRIAL BALANCES,
AND FINANCIAL STATEMENTS
FIGURE 6-3
The Cycle Approach to segmenting an audit
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
FIGURE 6-5 Relationships among Transaction Cycles
General
Cash
Capital Acquisition
and Repayment Cycle
Sales and
Collection
Cycle
Inventory and
Warehousing
Cycle
Acquisition and
Payment
Cycle
Payroll and
Personnel
Cycle
Arens,Loebbecke; Auditing,8/E
2000 Prentice Hall,Inc.
SETTING AUDIT OBJECTIVES
Figure 6-6 Balance and Transactions Affecting Those Balances
for Accounts Receivable
Accounts Receivable
Beginning balance $ 96
$660Sales
Ending balance $105
$590
$ 26
$ 35
Cash receipts
Sales returns
and allowances
Charge-off of
uncollectible
accounts
