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AUDITING 4 CLASS NOTES
The main concepts of Auditing 4 are the procedures used to test financial statement balances
and transactions (i.e., substantive testing), audit documentation, and audit evidence.
Transaction cycles include cycles for revenue, expenditures, payroll and personnel,
inventory and production, property, plant, and equipment, investments, and other
For each of these cycles, the auditor wants to answer two crucial questions:
Are controls operating effectively?
Have transactions, balances, and disclosures been recorded properly in
accordance with GAAP?
In the textbook you will see each transaction cycle presented in three ways: in written
sentences, as a flowchart, and in a chart.
Pay attention to the division of
responsibilities as shown in the flowcharts, and how the auditor might test the
controls shown in the charts.
It is the company's responsibility to properly segregate duties and implement
The auditor's responsibility is to evaluate those controls, decide
whether or not to rely on them, and to determine the nature, extent, and timing of
substantive audit procedures.
For each transaction cycle, be aware of whether the account being examined is an
asset/revenue or a liability/expense.
This usually dictates whether the assertion of
existence or the assertion of completeness is being tested.
For assets/revenues, the focus is often on whether the account actually exists
(i.e., making sure the accounts are not overstated).
For liabilities/expenses, the focus is often on whether the items were actually
recorded (i.e., making sure the accounts are not understated).
If a flowchart is presented on the examination, it will typically present various
departments (showing segregation of duties), as well as show how a particular
transaction starts with a source document (e.g., a sales order) and is processed to
ultimate inclusion in the financial statements.
In evaluating each transaction cycle, the auditor should determine whether
management has implemented sound internal control (i.e., the auditor should see
evidence of PAID TIPS).
The revenue cycle includes sales, accounts receivable, and cash receipts.
Emphasis is on the existence assertion, as there is often a motivation to overstate
revenue and receivables.
Another important assertion is valuation.
Obtaining credit approval, preparing an
aging schedule, and the allowance for doubtful accounts relate to this assertion.
Proper segregation of duties is also important (pay attention to the responsibilities
assigned to each department).