Activity Based Risk Evaluation Model of Auditing - 2

 

Financial statements are simply a collection of assertions: For example, the expression "Inventory, at cost, $100,000" in a set of financial statements is in fact an assertion by management that, inter alia, inventory actually exists, that it is owned by the entity at balance date, that it cost $100,000 and that there is no other inventory. The objective of an audit can thus be expanded to gather and evaluate audit evidence of sufficient quantity and appropriate quality in order to be able to form an opinion on the reliability of the assertions by management inherent in those financial statements. Financial statements are considered 'reliable' if they are, in all material respects, complete, valid and accurate. That is, financial statements are reliable when they contain no material misstatements, which is, in effect, what management asserts when they prepare the financial statements.

Why an audit is performed: Auditors perform an audit so as to add credibility to management's inherent assertions included in the financial statements. If the audit is to have any value, the auditor's opinion as to the reliability of the assertions must be communicated to the users of the financial statements. The auditor 'communicates' the results of the audit through the audit report, a document, often just one page in length, that is attached to audited financial statements and that sets out the scope of the audit (i.e. the work the auditor has performed) together with the auditor's opinion on the reliability of the assertions inherent in the financial statements. Financial statement 'users' include such groups as shareholders, suppliers, customers, lenders, borrowers, potential investors, and regulatory authorities. Accordingly, the objective may be expanded to gather and evaluate audit evidence of sufficient quantity and appropriate quality in order to form, and communicate to the users of the financial statements, an opinion on the reliability of the assertions of management inherent in those financial statements for the purpose of adding credibility to those assertions.

Concept of management assertions. Management impliedly asserts that the financial statements do not contain any material misstatements. All misstatements can be categorized into one of three categories - completeness, validity or accuracy. Broadly speaking, a misstatement of completeness occurs when an item which should be included is not included; a misstatement of validity occurs when the information includes an item that should not be included; a misstatement of accuracy occurs when the information includes an item that should be included, but it is not included accurately. Thus, management impliedly asserts that the financial statements are, in all material respects, complete, valid and accurate.

Management assertions. There are two categories of assertions by management that are of particular concern to auditors: internal control assertions and financial statement assertions.