13: Substansive procedures - key financial statment figures

Question 1

Give 6 risks of material misstatement for tangible NCAs (and give ways to test)

Answer 1

COVE+P

Completeness - e.g. omission of assets owned by the company (asset register against f/s)
Obligations and rights - Company not actually owning the assets (Registration docs/title deeds)
Valuation - assets being undervalued by overcharging depreciation/not revalued in significant time or overvalued by inflating cost/valuation or undercharging dep. (Check dep calucations or get an expert to review)
Existence - the assets not actually existing or having been sold by the company
Presentation - assets incorrectly presented in F/S (Asset held for sale no longer NCA)

Question 2

How is R&D classified

Answer 2

Research always expensed to p&l

Development only capitalised if it meets the following: PIRATE

Probably future economic benefit
Intention to complete
Resources adequate to do so
Ability to use or sell
Technical forseability to complete
Expenditure can be measured reliably

Question 3

Give 4 risks of mistatement for intangible NCAs (and give test)

Answer 3

Existence - expenses being capitalised as NCAs inappropriately (refer to criteria - IAS38)
Valuation - Intangible assets being carried at wrong cost or valuation due to inflating cost/valuation. (Recalculate)
- Or due to charging inappropriate amortisation. (review procedures)
- Or due to impairment reviews not carried out appropriately (Ensure NCA tested for impairment)

Question 4

Give 6 risks of misstatement associated with Inventory

Answer 4

CCOVVE

Completeness - Not all inventory that exists being included in FS (Directional testing)
Cut off - Inventory actually been sold being included in F/S
Obligations and rights - Inventory belongs to third parties being included in F/S
Valuation - Inventory included in F/S at full value when damaged (Attend inventory count - consider condition).
Valuation - Inventory included in F/S at wrong value due to miscalculation of cost or cost used instead of NRV. (Recalculate)
Existence - Inventory that does not exist being included in F/S (Directional testing - physically show inventory as recorded in F/S)

Question 5

What controls will auditor be looking for during inventory counts?

Answer 5

COR

Counting - systematic counting to ensure all inventory is counted.
-Teams of two counters, one with counting and other checking, or two independent counts.
- External auditors will also complete test count
Organisation of count - supervision by senior staff (not normally involved with inventory).
-Restriction and control of production process and inventory movements during count
- Identification of damaged, obsolete, third party and returnable inventory
Recording - Serial numbering, control and return of all inventory sheets (ensure not pre-filled). Completed in ink and signed
- Record quantity, condition, stage of production and work in progress.
- Reconciliation with inventory records and investigation/correction of any differences.

Question 6

When is NRV likely to be less than cost

Answer 6

When items are
1. Damaged
2. Obsolete
3. sale items
4. Loss leaders

Question 7

Give risks of misstatement for recievables

Answer 7

Valuation - Debts uncollectable or overvaluing CA
Existence, R&O - Debts being contested by customers (delivery note should be signed by customer)

Question 8

What is the evidence of confirmation of receivables

Answer 8

Firms sends letters to clients to confirm trade receivables as audit evidence.

The letter is on client’s paper, signed by client and reply is sent directly to auditor in a pre paid envelope.

The method of requesting info for confirmation from client is either positive or negative

Question 9

Explain positive method

Answer 9

Customer is requested to give the balance / to confirm valuation of balance shown or state any disagreement

Question 10

Explain negative method

Answer 10

Customer is requested to reply only if the amount staed is disputed. Method provides less reliable audit evidence as lack of response could mean did not recieve it either end or they have no disputes etc.

Question 11

When should negative confirmation request be used?

Answer 11

Only when:

-Assessed risk of material misstatement is low
- Relevant controls are operating effectively
- Large number of small balances involved
- Substantial number of errors not expected

Question 12

What sample of customers should assurance providers focus on

Answer 12

• Material, risky accounts
• old, unpaid accs
• Accounts written off
• Accs with credit balances or nil balances

Question 13

Who do assurance providers have to carry out further work in relation to recievables customers?

Answer 13

Those who:
- Disagree with balance stated (positive/negative)
- Do not respond (Positive confirmation only)

Question 14

Give some alternative procedures to verify existence/rights and obligations

Answer 14

• Check reciept of cash after date
• Examine account to see if balance represents specific invoices and confirm validity to despatch notes
• Test company’s control over issue of credit notes and write-off of bad debts.

Question 15

What is the test for bad debts

Answer 15

Reviewing the cash received after date. This will provide evidence of collectability of debts (and hence valuation)

Question 16

Give risks of misstatement for bank

Answer 16

COVE
Rights and obligations/completeness - Not all bank balances owned by the client being disclosed e.g. overdraft
Valuation - Reconciliation differences between bank balance and cash book balance being misstated (recalculate)
Completeness/existence - Material cash floats being omitted or misstated

Question 17

How are bank balances confirmed/tested

Answer 17

Tested directly by obtaining 3rd party confirmations from client’s banks and reconciling these with accounting records in relation to CCOVE.

Banks may also hold securities (Assets - not just cash) which a request letter may ask for confirmation of these. Bank will require explicit written authority from client to disclose requested info. Assurance provider’s request must refer to client’s letter if authority.

Request should reach branch manager at least two weeks in advance of client’s y/e.
Bank confirmation should be sent directly from bank to assurance provider (to remain 3rd party evidence - client can’t change it)

Question 18

How can a company overstate their liquidity regarding bank reconciliation. How can this be audited?

Answer 18

Keeping cash book open to take credit for remittances actually recieved after the year end. Thus enhancing the balance at bank and reducing receivables as cash is more liquid than debt.

Assurance providers should examine the paying in slip to ensure the amounts were actually paid into the bank on or before balance sheet date

Question 19

How can a company understate their liquidity re bank rec. Audit by?

Answer 19

Recording cheques paid in the period under review which are not actually despatched until after Y/E. Thus decreasing balance at bank and reducing payables. This can contrive to present an artifically healthy looking ratio, low CL balance.

Assurance providers should check whether these were cleared within a reasonable time in the new period. If not, this may indicate despatch occured after Y/E.

Question 20

Give risks of misstatement for payables and testing

Answer 20

Completeness - entity understating its liabilities in the f/s
Rights & obs - Cut off between goods inward and liability being recorded being incorrect
Existence/R&O - Non-existent liabilities being declared (rare)

Test with directional testing of source doc e.g. payables ledger records and confirmations from suppliers against the F/S

Question 21

What are risks of misstatement for long term liabilities?

Answer 21

Completeness - not all LT liabilities have been disclosed
Valuation - not calculated correctly, or rights & obligations- disagreement with other party
Cut off - not included in correct accounting period
Presentation - Disclosure is incorrect (split age of bank loan not done properly - classifying different loans and their ages).

Question 22

what are audit tests for LT liabilities?

Answer 22

Completeness: Analytical procedures to prior year. 2. Inspect board minutes
Existence: Obatain and inspect confirmation from banks - bank letter
Rights and obligations - Obtain anbd inspect confirmation from banks - loan agreements
Valuation - recalculate, agreeing b/f to prior year
Presentation/disclosure - inspect classification e.g. CL VS NCL.

Question 23

what are risks of misstatements for revenue

Answer 23

1. Cut off - goods sold after y/e but accounted for before to make p/l look better
2. Rights - receivables disputes
3. Completeness

Question 24

Give auditor tests for revenue

Answer 24

Analytical procedures, seasonal/yearly comparisons.

Predictable relationships with other items in F/S - recievables

Inspect sample of individual transactions to sale invoices to ensure existence

Question 25

Give risks of purchases and (auditor tests)

Answer 25

Cut off - included in next years. (Analytical procedures due to strong relationships that purchases have with other items e.g. inventory/payables)

Completeness - omission of purchases to make f/s look more profitable. (inspect sample of transactions, purchase invoices, trace through system to ensure completeness)

Question 26

Give auditor tests for payroll costs

Answer 26

Analytical procedures carried out as strong relationships between number of staff, pay rates and overall costs.

Inspect sample of payroll records, time tracking done correctly, payed at correct rate.

Recalculate payroll

Sample of payments to employees and tax statements verified to bank statements.

Question 27

Give auditor tests for interest paid/recieved

Answer 27

Inspecting bank statements or confirmations from other lenders to ensure interest correctly paid or received.

Recalculate to ensure outstanding interest has been accrued.

Question 28

Give auditor test for expenses

Answer 28

Analytical procedures - Year on year comparisons and enquiring if anyuthing spotted is unusual

Inspect specific transactions to purchases invoices