ACCTG 33 – AUDITING AND ASSURANCE PRINCIPLES MARK FRANCIS G.

NG, CPA, MBA

MODULE

12 AUDIT ASSERTIONS AND AUDIT OBJECTIVES

LEARNING OUTCOMES

After studying this module, the learners are expected to:

1. Describe the relationship between audit assertions and audit objectives.
2. Describe how management assertions determine the audit procedures for significant accounts in the financial
statements.
3. Enumerate the various categories of audit assertions in a general audit and as provided by the ISAs.
4. State the relationship between audit audit techniques, audit procedures, and audit assertions.

CORE DISCUSSIONS

THE AUDIT HIERARCHY

Representations made by management which are embodied either

implicitly or explicitly in the financial statements. Audit assertions are
AUDIT ASSERTIONS the subject matter information of an audit of financial statements.

The goal of the auditor in an audit in respect of the particular financial

AUDIT OBJECTIVES statement assertion that involves a particular account balance or class
of transaction.

The specific procedures to be conducted by the auditor in order to

AUDIT obtain and evaluate audit evidence to support or contradict the
PROCEDURES representations made by management.

All the information needed by the auditor which either supports or

contradicts the representations made by management in the financial
statements. Obtaining and evaluating audit evidence constitute the
AUDIT EVIDENCE bulk of the work of the auditor in an audit of financial statements in
order to enable him to express an opinion on the financial statements
based on the evidence gathered and evaluated.

AUDIT Proof of all the evidence obtained by the auditor as well as proof
DOCUMENTATION that the auditor really conducted the audit.

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AUDIT ASSERTIONS

The general financial statement assertions in an audit of financial statements include:

§ Existence
§ Occurrence
§ Completeness
§ Rights and Obligations
§ Valuation or allocation
§ Accuracy
§ Cutoff
§ Classification
§ Presentation and Disclosure

CLASSIFICATIONS OF AUDIT ASSERTIONS

ASSERTIONS ABOUT CLASSES OF TRANSACTIONS AND EVENTS FOR THE PERIOD UNDER AUDIT

These are assertions that pertain to the transactions and events that occurred for the period under audit and include:

§ Occurrence. The occurrence assertion relates as to whether transactions and events that have been
recorded have actually occurred and pertain to the entity. For example, if management presents in its income
statement that there have been P1,000,000 in total sales for the period, they assert that all the sales
transactions totaling to P1,000,000 have actually occurred during the period and were valid transactions.

§ Completeness. The completeness assertion relates as to whether all transactions and events that occurred
during the period and that should have been recorded have bee recorded. Therefore, if a client fails to record
a valid revenue transaction, the revenue account will be understated. It should be noted that the auditor’s
concern with the completeness assertion is the opposite of the concern for the occurrence transaction. If the
company fails to meet the completeness assertion, the result is an understatement. On the other hand, if a
company records an invalid transaction (or a transaction that have not actually occurred), the result is an
overstatement.

§ Accuracy. The accuracy assertion addresses whether amounts and other data relating to recorded
transactions and events have been recorded appropriately. Appropriate methods for recording a transaction
or event are established by generally accepted accounting principles. For example, if a company records the
acquisition of a new equipment, its costs should include its purchase price plus all reasonable costs to install
it in order to conclude that the item has been recorded accurately.

§ Cutoff. The cutoff assertion relates to whether transactions and events have been recorded in the correct
accounting period. In order to support this assertion, the auditor’s procedures must ensure that transactions
occurring near year-end are recorded in the financial statements in the proper period. Thus, if the auditor
wants to test proper cutoff of revenue transactions at December 31, 2010, the auditor’s objective is to
determine that all 2010 sales have been recorded in 2010. Additionally, the auditor should also ensure that
no 2011 sales have been recorded in 2010 and that no 2010 sales have been recorded in 2011.

§ Classification. The classification assertion is concerned with whether transactions and events have been
recorded in the proper accounts. For example, management asserts that all direct cost transactions related
to inventory have been properly classified in either inventory or part of cost of sales.

ASSERTIONS ABOUT ACCOUNT BALANCES AT PERIOD END

These are assertions that pertain to items of assets, liabilities, and equity that are presented in the balance sheet as
of the period end which include:

§ Existence. The existence assertion addresses whether assets, liabilities, and equity interests exist at the
date of the financial statements. For example, management asserts that inventory shown on the balance
sheet exists and is available for sale.

§ Rights and Obligations. The rights and obligations assertion relates whether the entity holds or controls
the right to assets, and liabilities are the obligations of the company. For example, management asserts that
the entity has legal title or ownership to the machinery shown on the balance sheet. Similarly, amounts
recorded for loans payable reflect assertions that the entity has an obligation to pay a loan to the bank or
financial institution.

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 § Completeness. The completeness assertions addresses whether all assets, liabilities, and equity interests
that should have been recorded have been recorded. For example, management implicitly asserts that the
amount shown for accounts receivable on the balance sheet includes all such rights of the entity with its
debtors as of the balance sheet date.

§ Valuation and allocation. The valuation and allocation assertion relates to whether assets, liabilities, and
equity interests are included in the financial statements at appropriate amounts and any resulting valuation
or allocation adjustments are appropriately recorded. For example, management asserts that the inventory
on the balance sheet is properly carried at the lower of cost or market value, or that the accounts receivable
are presented at net realizable value. Similarly, management asserts that the cost of building and items of
property, plant, and equipment is systematically allocated to appropriate accounting periods through the
recognition of depreciation expense.

ASSERTIONS ABOUT PRESENTATION AND DISCLOSURE

This classification of transactions relates to the presentation of information in the financial statements and disclosures
in the notes to financial statements that are directly related to a specific transaction or account balance and those
that apply to the financial statements in general.

§ Occurrence and Rights and Obligations. The assertions about occurrence and rights and obligations
address whether disclosed events, transactions, and other matters have occurred and pertain to the entity.
For example, when management presents capitalized lease transactions on the balance sheet as leased
assets, the related liabilities as long-term debt, and the related footnote, it is asserting that a lease
transaction occurred, it has a right to the leased asset, and it owes the related lease obligation to the lessor.
Additionally, there is a footnote disclosure that provides additional information on the lease such as future
payments.

§ Completeness. The completeness assertion relates to whether all disclosures that should have been
included in the financial statements have been included. For example, management asserts that no material
disclosures have been omitted from the footnotes and other disclosures accompanying the financial
statements.

§ Classification and Understandability. The assertions about classification and understandability relate to
whether financial information is appropriately presented and described, and disclosures are clearly
expressed. For example, management asserts that the portion of a long-term note payable shown as a
current liability will mature in the current year. Similarly, management asserts, through footnote disclosure,
that all major restrictions on the entity resulting from debt covenants are disclosed.

§ Accuracy and Valuation. The accuracy and valuation assertions relate to whether financial and other
information are disclosed fairly and at appropriate amounts. For example, when management discloses the
fair value of financial instruments, it is asserting that these financial instruments are properly valued in
accordance with GAAP. In addition, management may disclose in a footnote other information related to
financial instruments

RELATIONSHIP BETWEEN AUDIT ASSERTIONS AND AUDIT OBJECTIVES

Audit assertions and audit objectives should be congruent with one another. This means that in an audit of financial
statements, audit assertions serve as the starting point of the auditor to identify the specific goals he or she has to
accomplish in the conduct of the audit. This makes audit assertions and audit objectives essentially similar with each
other. The table below shows an example of and the congruence between audit assertions and audit objectives in
the audit of receivables.

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 AUDIT ASSERTIONS AND RELATED AUDIT OBJECTIVES
IN THE AUDIT OF RECEIVABLES

AUDIT ASSERTIONS AUDIT OBJECTIVES

Existence To determine that accounts receivables exist at the balance sheet date

Occurrence To prove that all credit sales transactions pertaining to the accounts receivables
that were recorded in the period have actually occurred

Completeness To ensure that all credit sales transactions pertaining to the accounts receivables
that occurred during the period have been recorded completely

Rights (and Obligations) To prove that the company has ownership or rights to the accounts receivables

Valuation or Allocation To determine that the accounts receivables are properly valued at net realizable
value

Accuracy To ensure that the computation of the accounts receivables and its valuation are
accurate and appropriately recorded

Cutoff To determine that all credit transactions to which the accounts receivables pertain
to have been recorded in the correct accounting period

Classification To see to it that accounts receivable are properly classified in the financial
statements as current assets

Presentation and To find proof that all presentation and disclosure requirements pertaining to
Disclosure accounts receivables have been presented and disclosed

REVIEW QUESTIONS:

1. Briefly discuss the audit hierarchy that serves as a guide to the auditor in the audit process.
2. What are audit assertions? Enumerate the general examples of audit assertions. How are audit assertions
classified in PSA 315? Briefly discuss each classification and give examples.
3. Explain the relationship that exists between audit assertions and audit objectives. What is meant by
congruence between audit assertions and audit objectives?

PRACTICE EXERCISE

Multiple Choice
Identify the choice that best completes the statement or answers the question. Use CAPITAL LETTERS.

1. Recalculations of the client’s computations would not include which of the following types of evidence?
A. cutoff. C. extension.
B. footing. D. cross-footing.

2. The following statements were made in a discussion of audit evidence between two CPAs. Which statement is not
valid concerning audit evidence?
A. "I am seldom convinced beyond all doubt with respect to all aspects of the statements being examined."
B. "I would not undertake that procedure because at best the results would only be persuasive and I'm looking for
convincing evidence."
C. "I evaluate the degree of risk involved in deciding the kind of evidence I will gather."
D. "I evaluate the usefulness of the evidence I can obtain against the cost of obtaining it."

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 3. The third general auditing standard requires that due professional care be exercised in the performance of the
examination and the preparation of the report. The matter of due professional care deals with what is done by the
independent auditor and how well it is done. For example, due care in the matter of audit documents requires that
audit documents'
A. Format be neat and orderly and include both a permanent file and a general file
B. Content be sufficient to provide support for the auditor's report, including the auditor's representation as to
compliance with auditing standards
C. Ownership be determined by the legal statutes of the state where the auditor practices
D. Preparation be the responsibility of assistants whose work is reviewed by seniors, managers, and partners

4. Vouching is used primarily to test which of the following assertions about classes of transaction?
A. Occurrence C. Authorization
B. Completeness D. Classification

5. Which one of the following represents a classification of control deficiency?

A. A missing control that is required for achievement of objectives.
B. A control that operates as designed.
C. A control that ensures the reliability of financial reporting.
D. An immaterial individual misstatement in internal control.

6. The inspection of a vendor's invoice by the auditors is:

A. Direct evidence about occurrence of a transaction
B. Physical evidence about occurrence of a transaction
C. Documentary evidence about occurrence of a transaction
D. Part of the client's accounting system

7. Confirmation would be most effective in addressing the existence assertion for the:
A. Addition of a milling machine to a machine shop
B. Payment of payroll during regular course of business
C. Inventory held on consignment
D. Granting of a patent for a special process developed by the organization

8. An audit program is created to specify:

A. the type of audit opinion to be rendered based upon procedures performed.
B. the audit procedures that will be performed every year for the client.
C. how an auditor should think while performing audit procedures.
D. audit objectives and procedures to be followed during the audit process.

9. A graphic representation of an accounting application that normally identifies key controls that are effective in
achieving specific control policies and procedures is
A. an internal control questionnaire. C. an internal control narrative.
B. a flowchart. D. a walk-through.

10. Which one of the following would be the most persuasive type of evidence?
A. check register C. observation of assets
B. bank statement D. inquiry with the in-house attorney

11. Vouching of transactions deals with

A. testing forward. C. testing at a point in time.
B. testing backward. D. directional testing either forward or backward.

12. Which of the following is true about analytical procedures?

A. Performing analytical procedures results in the most reliable form of evidence
B. Analytical procedures are tests of controls used to evaluate the quality of a client's internal control
C. Analytical procedures are used for planning, but they should not be used to obtain evidence as to the
reasonableness of specific account balances
D. Analytical procedures are used in planning, as a substantive procedure for specific accounts, and in the final
review of the audited financial statements

13. Which statement concerning audit evidence is not valid?

A. The auditor is seldom convinced beyond all doubt with respect to all aspects of the statements being audited
B. The auditor performs tests to collect convincing evidence that the financial statements are not misstated
C. The auditor weighs the cost of obtaining evidence with its usefulness
D. The auditor considers the amount of risk present in deciding the nature and extent of evidence to be collected

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14. Which of the following is the least persuasive documentation in support of an auditor's opinion?
A. Schedules of details of physical inventory counts conducted by the client
B. Notation of inferences drawn from ratios and trends
C. Notation of appraisers' conclusions documented in the auditor's working papers
D. Lists of negative confirmation requests for which no response was received by the auditor

15. Lease capitalization is best described by which of the following account balance assertions?
A. Existence or occurrence
B. Completeness
C. Rights and obligations
D. Presentation and disclosure

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