 In this presentation we will take a look at audit versus financial accounting. We'll also take a look at managerial assertions as we think about the creation of the financial statement with regards. Support accounting instruction by clicking the link below giving you a free month membership to all of the content on our website broken out by category further broken out by course. Each course then organized in a logical reasonable fashion making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again click the link below for a free month membership to our website and all the content on it to an audit process taking place for them. When we think about financial accounting and audit we usually study these in order. So if we're going to go into accounting we typically start off with financial accounting and then at some point we might move to audit studying audit. One of the reasons we have this process in that way one of the reasons we don't learn audit and then the financial accounting is because the financial accounting is really where we learn to construct something. We start from nothing transactions concepts we learn to then construct the financial statements that in product with it. I would compare this in analogy to constructing something like a building. Now you would think that constructing the building would be more difficult than going back to the building and testing it to see if the building was put together in a structurally sound way which is similar to what is done in an audit. If we audit something then we're taking a look at the end product of financial statements typically with financial accounting types of audits. But if we compare that to a building we'd be taking the building we're saying is the building structurally sound similar type of process with an audit. We'll think of course the construction of the building or the construction of the financial statement more difficult than going back and saying OK is the thing that has been constructed done well done properly. And in many cases it is in a lot of ways the financial statement creation is more difficult in a lot of ways because we're actually building something from nothing. We're taking the financial statement transactions we're putting them together we are constructing the end result those being the financial statements. However as we put this information together it's pretty well detailed how we're supposed to do each particular step. We could think about putting the Lego set together to put our building together and the instructions are pretty straightforward. They're well defined when we start to record the transactions. We say I have a question about how to record this transaction which account should be debited and credited which account should be going up or down. We consult the regulations we look at generally accepted accounting principles we get the answer we record the transaction in accordance with the rules very specific rules. As we follow those rules in a very specific way we construct our financial statements and get to that end result. So it's a long process tedious process takes a lot of work. But as we go through each step in the process there usually are going to be a set of rules that we can go through and follow fairly closely. When we think about the audit side of things now what we're doing is we're taking the end product we could say the building or the financial statements. We're tech we're testing to see if it's going to be sound is the building structurally sound could it hold up say to an earthquake or something like that or like it's supposed to. Are the financial statements structurally sound are they complete do they have everything that should be in it do they have an accurate representation or reflection of the financial condition and performance of the company over a certain time period. Now you would think that would be easier to look into but it's a little bit confusing to think about that if we have the building you can say well the building looks structurally sound it's solid. How do I know it would stand up if you had an earthquake or something it's supposed to stand up if you have a seven point some earthquake how would I test for that I don't know it'd be a little bit difficult to go into that. And in order to test for that we're learning a few different things one we're going to be learning the financial accounting principles much more clearly. Because oftentimes what we do is we memorize what we're doing if I'm going to put something together like a building and you ask me why I put something together. I just say hey look this is what the direction says and I follow the direction and I got to the end product of the building. The directions of course have rule have reasons for them they follow the accrual principle and they have more reasons but oftentimes as we follow the directions we just follow the directions. And we can do that pretty clearly with financial accounting when we get into the audit and we have to test whether or not something has been built in a structurally sound way. We not only have to follow the directions we have to know the meaning of the direction. What are the actual principles being followed such as the accrual principle revenue recognition principle the matching principle or expense recognition principle we have to know those well and then actually construct ways that we can test for soundness. If we're looking at the building how can we test if this thing would fall over without actually having an earthquake to make it fall over. If we're testing the financial statements how can we test that it's accurate complete without actually basically testing the whole thing or taking the whole thing apart or doing so in some type of time frame that's going to be easier to do. So learning audit will help us basically to better understand the concepts of financial accounting in a much more rigorous type of way. We're going to be deconstructing in some ways what's been put together in very strategic type of ways to do so in a way that's going to save the most amount of time. As we do so we have to know what's been built and why it's been built how it's been built how can we then find ways to test the construction of it to see if it has been built in accordance with rules and regulations. And in order to know that we need to know what the gist or why those rules and regulations have been put together. Therefore the audit is going to be applying things over and above just normal principles to build the actual thing we got to look at analytical type of skills we got to think about what are the assertions behind the cruel principle of revenue recognition and expense recognition or matching principle. How can we test for things how can we put something together to test to those principles apply out those tests and then try to determine whether or not those tests are sufficient for us to be able to determine whether or not something has been put together accurately. So for example if we take a look at the management type of assertions will recall that the financial statements are built by the company company run by management management's responsible for putting together the financial statements. The auditor then is responsible for testing the financial statements in some way. So by the company putting together the financial statements they are making assertions their assertions involved. Basically things that the management is saying hey these financial statements represent these assertions within them they have been constructed in accordance with these assertions. We as the auditor then want to take those financial statements look at those assertions and then determine whether or not that is indeed the case or not. As we go through these assertions then we want to have an idea that we're not going to go through them in a lot of detail here. But we want to get them in our head as we go so then when we start to create the audit when we start to test these things we really need to know exactly what assertion we are testing. Common test question that people miss all the time common conceptual problem that people have within audits is that we have the same thing that we have within financial accounting. We know the rule we read the rule book we know we're supposed to do this process here we know we're supposed to do this audit test here. We don't know why though we don't know what the assertion is we don't know what it is exactly that we are testing that's where people often run into problems. So we want to basically list these assertions and then start to visualize in our mind and say what kind of testing could we do to basically test for these types of assertions to see if this has been done in the correct way. Again common types of test questions that people have problems with is matching up the actual assertion to the test that they know they have to create but they don't really understand what the assertion is. So these are management assertions about classes of transactions and events and related disclosures. First assertion occurrence occurrence transactions and events that have been recorded or disclosed have occurred and such transactions and events pertain to the entity. So we have to obviously if we have financial statements and they're representing the fact that a sale happened. We want to know did that really happen or are they trying to inflate the financial statements or for some reason or the other you know is it a fictitious basic sale for one reason or another. We need to we need to know that something actually did happen that's being represented on the financial statement. Completeness all transactions and events that should have been recorded have been recorded and all related disclosures that should have been included in the financial statements have been included. So now we're looking at the other side of things we're saying well these financial statements don't represent you know some type of transaction that possibly should be there. Is that the case? Could it be the case that say a large expenditure that should be on the books somehow isn't there. Depreciation wasn't recorded or something like that or the financial statements complete is everything that should have been recorded been recorded. Authorization all transactions and events have been properly authorized accuracy amounts and other data related to recorded transactions and events have been recorded appropriately and related disclosures have been appropriately measured and described cut off transactions and events have been recorded in the correct accounting period. So some people might not be as familiar with the term cut off. You can think of cut off that what should come to mind in terms of financial accounting are the adjusting entries at the end of the time period. When we're thinking about timing differences is something recorded in the proper time period. Should it be recorded should revenue be included at say if it's a if it's a December year end in the current year or should it be included in the following year. Oftentimes errors within financial accounting as well as fraud could take place by having revenues and expenses recorded in the in the wrong time period either. So we want to check the cutoffs at the beginning of the year and the end of the year to check whether or not they're in the correct time period. Our classification transactions and events have been recorded in the proper accounts and presentation. Transactions and events are appropriately aggregated or disaggregated and clearly described and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework. Now we're going to take a look at management assertions related to account balances and related disclosures. So we're looking at assertions related to account balances now. So when we're looking at the actual account you can imagine basically going through the balance sheet checking off these accounts. We can compare this to our building type of analogy. If we want to look at the structural soundness of the building what are we going to do we can find things and basically test those things. If we look at the financial statements we could think about well one of the first places we start might be that we take the balance sheet look at something like cash. Check it out. See if we can test that look at something like the accounts receivable check it out. We can take apart the financial statements of course by looking at those actual accounts and possibly testing for those actual accounts. So when we're looking at the account balances then we're looking at things like existence. So is there existence of assets liabilities equity note when you're thinking about these things as well we're usually skeptical about the financial statements being overstated. And so we're usually skeptical about basically if I was thinking about existence you want to think well I might be more skeptical towards cash than liabilities because it's more likely that they might put something like cash or an asset on the books in order to look good as opposed to putting a liability on the books that doesn't exist that would make them look worse. So as you look through these types of assertions keep in your mind as an auditor you're probably looking to be skeptical towards the financial statements looking better rather than worse. Now it's possible that they actually put something together to look worse. When would you want to look worse? There's a lot of times that a company might want to look worse. So there's one time in particular where companies would want to look worse and may take actions fraudulent actions possibly to deceive in order to look worse. And that would of course be related to taxes. So those two things are always going the opposite direction. If someone's trying to look bad or trying to put something together just for tax purposes they're often more likely to look worse because if they look worse then they pay less taxes. You don't go to the tax collector driving up in the couple hundred thousand dollar car or anything like that. Typically people try to look worse but any other time then companies usually try to look better. And if you're talking about publicly traded companies or a company looking for a loan or a company trying to get equity investments typical type of things companies do everything other than taxes then the company will typically be trying to look better than they may look. And so that's usually the perspective that we're looking at because we're usually not representing just the IRS. It's not the main user possibly of the financial statements. The main users of the financials and the reader for the audit might be for investors. For publicly traded companies we're typically looking out for investors. We're typically looking out for in terms of the audit for people that might do business such as people that might give a loan banks and things like that. And therefore again skeptical usually on the financial statements being overstated looking better. And therefore as you look at these assertions and think about testing you probably going to have that kind of skeptical slant towards your perspective on how to put together the procedures rights and obligations. The entity holds or controls the rights to assets and liabilities and are the obligations of the entity. So they have actually have the rights and obligations to the assets and liabilities being reported. Then we have completeness all assets liabilities and equity interests that should have been recorded have been recorded and all related disclosures that should have been included in the financial statements have been included in the financial statements. Then we have accuracy valuation and allocation assets liabilities and equity interests have been included in the financial statement at appropriate amounts and any resulting valuation or allocation adjustments have been appropriately recorded and related disclosures have been appropriately measured and described. Classification assets liabilities and equity have been recorded in the proper accounts and then of course presentation assets liabilities and equity are appropriately aggregated or disaggregated and clearly described and related disclosures are relevant and understandable in the context of the requirements of the applicable financial reporting framework. Typically being something like generally accepted accounting principles gap.