. List the five assertions management makes to the auditor and explain each assertion in the context of the Fixed Asset accounts.

Existence or Occurrence Assertion

Completeness Assertion

Rights and Obligations Assertion

Valuation or Allocation Assertion

Presentation and Disclosure Assertion

LO 5 Describe the assertions integral to the financial statements and explain their importance to the audit opinion formulation process. Audit Opinion Formulation Process: Financial Statement Assertions Within each cycle, the audit is designed around management's assertions inherent in the financial statements. For example, if an organization asserts that it has prop- erty, plant, and equipment {PPE}, net of depreciation of $42 million, the assertions being made by management include: 1. PPE is physically present (existence). 2. All purchases of PPE are fully recorded {completeness}. Audit Opinion Formulation Process: Financial Statement Assertions - 3. It owns the PPE and has title to the equipment (rights and obligations). 4. The PPE is properly valued at cost with applicable allowances for depreciation {valuation}. 5. The PPE is appropriately classified and described (presentation and disclosure) These five assertions are the ones we refer to throughout the textbook. The AJCPA and 1AASB have a similar conceptual structure for their assertions, although in some cases the wording differs somewhat from this wording. The auditor's job is to obtain evidence related to these management assertions for each significant account and disclosure in the financial statements. As part of this process, auditors identify the most relevant assertions associated with the significant accounts and disclosures. Relevant assertions are those having a mean- ingful bearing on whether a financial statement account is fairly stated. While multiple assertions likely have a bearing on a financial statement account or disclosure, certain financial statement assertions are \"more\" relevant than oth- ers for particular financial statement accounts. For example, valuation is not particularly relevant to the cash account, unless currency translation is involved. However, existence would be considered very relevant to the cash account. As another example, valuation is especially relevant for the inventory account. The type of account inuences the assertions considered most relevant. In gen- eral, assets and revenues are more likely to be overstated, so existenceloccurrence is the more relevant assertion for those accounts. In contrast, completeness would be the more relevant assertion for liabilities and expenses, as management would be more likely to understate these accounts. Accounts that require subjective iudg- ments by management {such as allowance for loan loss reserve or allowance for inventory obsolescence] will usually have valuation as a more relevant assertion, as the valuation assessment is subject to management bias. Existence or Occurrence Assertion Assertions about existence address whether all assets and liabilities recorded in the financial statements exist. For example, an auditor wants assurance that all of the property and equipment included in the client's balance sheet actually exists. Assertions about occurrence address whether all transactions recorded in the nancial statements have occurred. For example, an auditor wants assurance that all of the recorded sales transactions have occurred. The existenceioccurrence assertion is generally most relevant for accounts where the auditor is concerned that management has an incentive to overstate the ending balance. Consider a situation in which management asserts that the sales revenue recorded in the income statement represents all valid sales transactions that occurred during the period. The auditor is concerned that management may have an incentive, e.g., financial performance-based executive compensation, to overstate sales revenue. A common method for overstating sales revenue would be for management to record the first week's sales in 20X1 in the current period ZOXO, i.e., accelerating the rec- ognition of sales revenue. The revenue from the first week's sales in 20X1 did not occur during the current period, thus management violated the occurrence assertion. Common accounts for which the existence or occurrence assertion is relevant include revenue and assets (e. g., inventory, fixed assets). Completeness Assertion Assertions about completeness address whether all transactions and accounts that should be included in the financial statements are included. Has anything been left out of the financial statements? This assertion is generally most relevant for accounts for which the auditor is concerned that management has an incentive to understate the ending balance. Consider a setting in which management asserts that accounts payable in the balance sheet includes all accounts payable that the organization owes. The auditor ter 5 ' Professional Auditing Standards and the Audit Opinion Formulation Process is concerned that management may have an incentive, perhaps based upon debt covenants with their bank, to understate short-term liabilities, e.g., accounts pay- able. A common method for understating accounts payable would be for manage- ment to neglect recording the last week's accounts payable for the current period 20x0 until the first week of ZOXI, i.e., delaying recording the liability. Common accounts for which the completeness assertion is relevant include expenses and liabilities (e.g., accounts payable). Rights and Obligations Assertion Assertions about rights address whether recorded assets are the rights of the organization. The auditor is concerned that management may have an incentive, e.g., financial performance-based executive compensation, to improperly claim that they have a right to a revenue or asset. Consider a situation in which management asserts that they own inventory that is in their warehouse. The auditor's concern is that while the inventory does physically exist (i.e., the existence assertion), it is not actually owned by the orga- nization. This situation could arise when management fraudulently includes goods in its ending inventory for which they do not have legal title {e.g., goods that are on consignment, or goods that they have 'borrowed' and will return to their original owner after the ending inventory count has been taken). Exhibit 5.5 illustrates this situation. Management recorded an ending inventory amount, indicating that their organization owned the inventory. If the misstatement is intentional, a fraud exists because the organization does not have legal title, or rights, to the inventory. The result is a classic inventory fraud, whereby management acts in some way to overstate ending inventory and thereby overstate nancial reporting profitability. Assertions about obligations address whether recorded liabilities are the obligations of the organization. In some cases, a client may intentionally over- state a liability (and related expense) to avoid paying taxes. The auditor needs to understand the client's motivations to assess whether such a risk is present. Common accounts for which the rights and obligation assertion is relevant include assets and liabilities. Valuation or Allocation Assertion Assertions about valuation or allocation address whether accounts have been included in the nancial statements at appropriate amounts. The auditor is con- cerned that management may have an incentive, e.g., financial performance- based executive compensation, to improperly value revenues, expenses, assets, and liabilities. As an example, management might improperly undervalue bad debt expense and the allowance for doubtful accounts in order to show higher, i.e., more favor- able net accounts receivable. Common accounts for which the valuation or allocation assertion is relevant include revenue, expenses, assets, and liabilities (everythingl). hapter 5 ' Professional Auditing Standards and the Audit Opinion Formulation Process Presentation and Disclosure Assertion Assertions about presentation and disclosure address whether components of the financial statements are properly classified, described, and disclosed. For example, management might assert that obligations classified as long-term liabilities in the balance sheet will not mature within one year. The auditor is concerned that the liabilities will mature within a year and that the organization's presentation on the face of the balance sheet does not conform with GAAP requirements. In addi- tion, the auditor will test the disclosure assertion by examining the footnotes to the financial statements for the long-term liability balance and the relevance and appropriateness of management's disclosures