16 Liabilities, Capital & directors Emoluments

Question 1

Assertions about classes of transactions and related disclosures: (occurrence, completeness, accuracy, cut off, classification)

Answer 1

– All purchase transactions recorded have occurred and relate to the entity (occurrence). – All purchase transactions that should have been recorded have been recorded (completeness). – Amounts relating to transactions have been recorded appropriately (accuracy). – Purchase transactions have been recorded in the correct period (cut-off). – Purchase transactions are recorded properly in the accounts (classification).

Question 2

Assertions about classes of transactions and related disclosures: (presentation)

Answer 2

– All disclosed events and transactions relating to liabilities have occurred and relate to the entity (presentation). – All disclosures required have been included (presentation). – Financial information is appropriately presented and described and disclosures clearly expressed (presentation). – Financial information is disclosed fairly and at appropriate amounts (presentation).

Question 3

Assertions about period-end account balances and related disclosures:(existence, rights and obligation, completeness, valuation and allocation, presentation)

Answer 3

– Trade payables and accrued expenses are valid liabilities (existence). – Trade payables and accrued expenses are the obligations of the entity (rights and obligations). – All liabilities have been recorded (completeness). – All liabilities are included in the accounts at appropriate amounts (valuation and allocation). – All disclosures required have been included (presentation). – Financial information is appropriately presented and described and disclosures clearly expressed (presentation). – Financial information is disclosed fairly and at appropriate amounts (presentation).

Question 4

As regards trade accounts payable, this primary objective can be subdivided into two detailed objectives:

Answer 4

 Is there a satisfactory cut-off between goods received and invoices received, so that purchases and trade accounts payable are recognised in the correct year?  Do trade accounts payable represent the bona fide amounts due by the company?

Question 5

What is the role of auditors in audit procedures in accounts receivable?

Answer 5

uditors should be particularly aware, when conducting their work on the statement of financial position, of the possibility of understatement of liabilities to improve liquidity and profits (by understating the corresponding purchases). The primary objective of their work will therefore be to ascertain whether liabilities existing at the year end have been completely and accurately recorded.

Question 6

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLES AND ACCRUALS (Completeness):

Answer 6

 Obtain a listing of trade accounts payables and agree the total to the general ledger by casting and cross-casting.  Test for unrecorded liabilities by enquiries of management on how unrecorded liabilities and accruals are identified and examining post year end transactions.  Obtain selected suppliers’ statements and reconcile these to the relevant suppliers’ accounts (see Section 2.3 for details of suppliers’ statements).  Examine files of unmatched purchase orders and supplier invoices for any unrecorded liabilities.

Question 7

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLES AND ACCRUALS (Completeness): PART 2

Answer 7

 Perform a confirmation of accounts payables for a sample (see Section 2.2 for details of the accounts payables’ confirmation).  Complete the disclosure checklist to ensure that all the disclosures relevant to liabilities have been made.  Compare the current year balances for trade accounts payables and accruals with the previous year.  Compare the amounts owed to a sample of individual suppliers in the trade accounts payables listing with amounts owed to these suppliers in the previous year.

Question 8

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLES AND ACCRUALS (Completeness): PART 3

Answer 8

 Compare the payables turnover and payables days to the previous year and industry data.  Reperform casts of payroll records to confirm completeness and accuracy.  Confirm payment of net pay per payroll records to cheque or bank transfer summary.  Agree net pay per cashbook to payroll.  Inspect payroll for unusual items and investigate them further by discussion with management.  Perform proof-in-total (analytical procedures) on payroll and compare to figure in draft financial statements to assess reasonableness.

Question 9

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLES AND ACCRUALS (eXISTANCE)

Answer 9

 Vouch selected amounts from the trade accounts payables listing and accruals listing to supporting documentation, such as purchase orders and suppliers’ invoices.  Obtain selected suppliers’ statements and reconcile these to the relevant suppliers’ accounts.  Perform a confirmation of accounts payables for a sample.  Perform analytical procedures comparing current year balances with the previous year to confirm reasonableness, and also calculating payables’ turnover and comparing with the previous year.

Question 10

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLE S AND ACCRUALS (Rights and obligations)

Answer 10

 Vouch a sample of balances to supporting documentation, such as purchase orders and suppliers’ invoices, to obtain audit evidence regarding rights and obligations.

Question 11

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLE S AND ACCRUALS (Accuracy, valuation and allocation)

Answer 11

 Trace selected samples from the trade accounts payables listing and accruals listing to the supporting documentation (purchase orders, minutes authorising expenditure, suppliers’ invoices etc).  Obtain selected suppliers’ statements and reconcile these to the relevant suppliers’ accounts.  For a sample of accruals, recalculate the amount of the accrual to ensure the amount accrued is correct.  Compare the current year balances for trade accounts payables and accruals with the previous year

Question 12

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLE S AND ACCRUALS (Accuracy, valuation and allocation) PART 2

Answer 12

 Compare the payables turnover and payables days with the previous year and industry data.  Recalculate the mathematical accuracy of a sample of suppliers’ invoices to confirm the amounts are correct.  Recast calculation of remuneration.  Reperform calculation of statutory deductions to confirm whether correct. Confirm validity of other deductions by agreeing to supporting documentation.  Recast calculation of other deductions.

Question 13

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLE S AND ACCRUALS (Cut-off)

Answer 13

 For a sample of vouchers, compare the dates with the dates they were recorded in the ledger for application of correct cut-off.  Test transactions around the year end to determine whether amounts have been recognised in the correct financial period.  Perform analytical procedures on purchase returns, comparing the purchase returns as a percentage of sales or cost of sales to the previous year

Question 14

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLE S AND ACCRUALS (Occurrence)

Answer 14

 For a sample of vouchers, inspect supporting documentation, such as authorised purchase orders.  Agree individual remuneration per payroll to personnel records, records of hours worked, salary agreements etc.  Confirm existence of employees on payroll by meeting them, attending wages payout, inspecting personnel and tax records, and confirmation from managers.  Agree benefits on payroll to supporting correspondence.

Question 15

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLE S AND ACCRUALS (Classification)

Answer 15

 Review the trade accounts payables listing to identify any large debits (which should be reclassified as receivables or deposits) or long-term liabilities which should be disclosed separately.  Read the disclosure notes relevant to liabilities in the draft financial statements and review for understandability.

Question 16

The audit procedures related to statement of profit or loss items are shown in italics. AUDIT PLAN: ACCOUNTS PAYABLE S AND ACCRUALS (Presentation)

Answer 16

 Read the disclosure notes to ensure the information is accurate and properly presented at the appropriate amounts.

Question 17

Audit procedures in relation to purchases, other expenses and wages costs

Answer 17

(a) Inspect a sample of purchase invoices to ensure they agree to the amount posted to the general ledger. (b) Compare expenses making up administrative expenses to the prior year charge and to expectations on a line by line basis. Where differences from expectations are discovered they should be investigated. (c) Enquire of management whether there are any unsettled claims or obligations arising before the year end and ensure these are provided for (to give evidence over the completeness of the charge in the related expense category in the statement of profit or loss)

Question 18

Audit procedures in relation to purchases, other expenses and wages costs. part 2

Answer 18

(d) Recalculate accruals and prepayments to gain evidence that other expenses are not over- or understated. (e) Compare gross profit margin with the previous year, the gross margin per the budget and expectations. Investigate any unexpected fluctuations.

Question 19

One expense that may make up a significant proportion of expenses is the wages cost included in statement of profit or loss. How do you reconcile the wages costs?

Answer 19

(a) Reconcile the gross costs on the payroll to the wages cost in the financial statements. (b) Reperform casts of payroll records to confirm completeness and accuracy of costs used as a basis for the journals to the financial statements. (c) Confirm payment of net pay per payroll records to cheque or bank transfer summary. (d) Inspect payroll for unusual items and investigate them further by discussion with management.(e) Perform proof-in-total (analytical procedures) on payroll by multiplying estimated average wage (using last year’s figures plus expected increases) by average number of employees (therefore incorporating starters and leavers) and compare to figure in draft financial statements to assess reasonableness. (f) Reperform calculations of statutory deductions to establish whether valid deductions have been included in the payroll expense.

Question 20

Reconciliations of accounts payables with suppliers’ statements. what should auditors not rely on

Answer 20

The auditor should not rely on photocopies or faxed statements. If there is any doubt, the auditor should request a copy directly from the supplier or confirm the balance with the supplier (see above)

Question 21

Whats more reliable internal or external evidence

Answer 21

Because they are a source of documentary evidence originating outside of the entity, they are a reliable source of evidence to support suppliers’ balances and provide evidence as to the existence, completeness and valuation of balances

Question 22

What do auditors need to primarily determine with non current liabilities

Answer 22

 Completeness: whether all non-current liabilities have been disclosed  Accuracy: whether interest payable has been calculated correctly and included in the correct accounting period  Classification: whether long-term loans and interest have been correctly disclosed in the financial statements

Question 23

The plan that follows contains procedures for non-current liabilities in the statement of financial position and the related interest charge in the statement of profit or loss

Answer 23

 Obtain/prepare schedule of loans outstanding at the year-end date showing, for each loan: name of lender, date of loan, maturity date, interest date, interest rate, balance at the end of the period and security.  Compare opening balances to previous year’s papers.  Test the clerical accuracy of the analysis.  Compare balances to the general ledger

Question 24

The plan that follows contains procedures for non-current liabilities in the statement of financial position and the related interest charge in the statement of profit or loss part 2

Answer 24

 Agree name of lender to register of debenture holders or equivalent (if kept).  Trace additions and repayments to entries in the cash book.  Confirm repayments are in accordance with loan agreement.  Examine cancelled cheques and memoranda of satisfaction for loans repaid.  Verify that borrowing limits imposed by agreements are not exceeded.

Question 25

The plan that follows contains procedures for non-current liabilities in the statement of financial position and the related interest charge in the statement of profit or loss part 3

Answer 25

 Examine signed board minutes relating to new borrowings/repayments.  Obtain direct confirmation from lenders of the amounts outstanding, accrued interest and what security they hold.  Verify that interest charged for the period is in accordance with statements and supporting agreements, and consistent with known interest rates. Consider the adequacy of accrued interest.  Confirm assets charged have been entered in the register of charges and notified to the Registrar.

Question 26

The plan that follows contains procedures for non-current liabilities in the statement of financial position and the related interest charge in the statement of profit or loss part 4

Answer 26

 Review restrictive covenants and provisions relating to default: – Review any correspondence relating to the loan – Review confirmation replies for non-compliance – If a default appears to exist, determine its effect, and schedule findings  Review minutes and cash book to confirm that all loans have been recorded.  Review draft accounts to ensure that disclosures for non-current liabilities are correct and in accordance with accounting standards. Any elements repayable within one year should be classified under current liabilities

Question 27

Define: provision ; liability ; obligating event ; legal obligation ; constructive obligation ; contingent liability

Answer 27

A provision is a liability of uncertain timing or amount. A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. A legal obligation is an obligation that derives from: (a) A contract (through its explicit or implicit terms); (b) Legislation; or (c) Other operation of law. A constructive obligation is an obligation that derives from an entity’s actions where: (a) By an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and (b) As a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. A contingent liability is: (a) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity (b) A present obligation that arises from past events but is not recognised because: (i) It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligatio

Question 28

Explain contingent asset

Answer 28

A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

Question 29

Examples of the principal types of contingencies disclosed by companies are:

Answer 29

 Guarantees (for group companies, of staff pension schemes, of completion of contracts)  Discounted bills of exchange  Uncalled liabilities on shares or loan inventory  Lawsuits or claims pending  Options to purchase assets

Question 30

Obtaining audit evidence of contingencies. The auditor shall design and perform procedures in order to identify any litigation and claims involving the entity which may give rise to a risk of material misstatement. Such procedures would include the following.

Answer 30

 Make appropriate enquiries of management and others including in-house legal advisers.  Review minutes of meetings of those charged with governance and correspondence between the entity and its external legal advisers.  Review legal expense accounts.  Use any information obtained regarding the entity’s business, including information obtained from discussions with any in-house legal department.

Question 31

if it is considered unlikely that the entity’s external legal advisers will respond appropriately to a letter of general inquiry, the auditor may seek direct communication through a letter of specific inquiry. This will include:

Answer 31

 A list of litigation and claims  Where available, management’s assessment of the outcome of each of the identified litigation and claims and its estimate of the financial implications, including costs involved  A request that the entity’s external legal advisers confirm the reasonableness of management’s assessments and provide the auditor with further information if they consider the list to be incomplete or incorrect

Question 32

What is the audit plan for provisions and contingencies

Answer 32

 Obtain details of all provisions which have been included in the accounts and all contingencies that have been disclosed.  Obtain a detailed analysis of all provisions showing opening balances, movements and closing balances.  Determine for each material provision whether the company has a present obligation as a result of past events by: – Review of correspondence relating to the item – Discussion with the directors. Have they created a valid expectation in other parties that they will discharge the obligation?

Question 33

What is the audit plan for provisions and contingencies? part 2

Answer 33

 Determine for each material provision whether it is probable that a transfer of economic benefits will be required to settle the obligation by: – Checking whether any payments have been made in the post year end period in respect of the item by reviewing after-date cash – Review of correspondence with solicitors, banks, customers, insurance company and suppliers both pre and post year end – Sending a letter to the solicitor to obtain their views (where relevant) – Discussing the position of similar past provisions with the directors. Were these provisions eventually settled? – Considering the likelihood of reimbursement

Question 34

What is the audit plan for provisions and contingencies? part 3

Answer 34

 Recalculate all provisions made.  Compare the amount provided with any post year end payments and with any amount paid in the past for similar items.  In the event that it is not possible to estimate the amount of the provision, check that a contingent liability is disclosed in the accounts.  Consider the nature of the client’s business. Would you expect to see any other provisions eg warranties?  Consider the adequacy of disclosure of provisions, contingent assets and contingent liabilities in accordance with IAS 37.

Question 35

AUDIT PLAN: CAPITAL AND RELATED ISSUES: SHARE EQUITY CAPITAL

Answer 35

 Agree the authorised share capital with the statutory documents governing the company’s constitution.  Agree changes to authorised share capital with properly authorised resolutions.

Question 36

AUDIT PLAN: CAPITAL AND RELATED ISSUES: ISSUE OF SHARES

Answer 36

 Verify any issue of share capital or other changes during the year with general and board minutes.  Ensure issue or change is within the terms of the constitution, and directors possess appropriate authority to issue shares.  Confirm that cash or other consideration has been received or receivable(s) is included as called-up share capital not paid.

Question 37

AUDIT PLAN: CAPITAL AND RELATED ISSUES:TRANSFER OF SHARES

Answer 37

 Verify transfers of shares by reference to: – Correspondence – Completed and stamped transfer forms – Cancelled share certificates – Minutes of directors’ meeting  Review the balances on shareholders’ accounts in the register of members and the total list with the amount of issued share capital in the general ledger.

Question 38

AUDIT PLAN: CAPITAL AND RELATED ISSUES: DIVIDENDS

Answer 38

 Agree dividends paid and declared pre year end to authority in minute books and reperform calculation with total share capital issued to ascertain whether there are any outstanding or unclaimed dividends.  Agree dividend payments to documentary evidence (say, the returned dividend warrants).  Test that dividends do not contravene distribution provisions by reviewing the legislation.

Question 39

AUDIT PLAN: CAPITAL AND RELATED ISSUES: RESERVES

Answer 39

 Agree movements on reserves to supporting authority.  Ensure that movements on reserves do not contravene the legislation and the company’s constitution by reviewing the legislation.  Confirm that the company can distinguish distributable reserves from those that are non-distributable.  Ensure that appropriate disclosures of movements on reserves are made in the company’s accounts by inspection of the financial statements.

Question 40

What are Directors’ emoluments ?

Answer 40

The auditor will need to make sure the disclosure of directors’ emoluments is complete, accurate and compliant with both applicable accounting standards and local legislation

Question 41

IAS 24 requires that the financial statements of a company disclose key management personnel compensation details in total. Key management will include the board of directors and compensation will include:

Answer 41

(a) Short-term employee benefits, such as wages, salaries and social security contributions, paid annual leave and paid sick leave, profit-sharing and bonuses and non-monetary benefits for current employees (b) Post-employment benefits, such as pensions, other retirement benefits, post-employment life insurance and post-employment medical care (c) Other long-term employee benefits, including long-service benefits and deferred compensation (d) Termination benefits (e) Share-based payments

Question 42

AUDIT PLAN: DIRECTORS’ EMOLUMENTS. What are the valid audit procedures when auditing directors emoluments? (part 1)

Answer 42

 For each director, obtain a schedule of emoluments for the year, split between wages, bonuses, benefits, pension contributions and other emoluments.  Check the addition of the schedule and ensure the totals are in agreement with the disclosure in the financial statements.  Ask each individual director to confirm the emoluments listed are complete and in line with their expectations.

Question 43

AUDIT PLAN: DIRECTORS’ EMOLUMENTS. What are the valid audit procedures when auditing directors emoluments? (part 2)

Answer 43

 Compare the emoluments with both the previous year’s emoluments and with expectations, taking into account the knowledge obtained during the audit (for example, if you know a director has left during the year, is there any compensation for loss of office expected?).  Agree salaries, fees, bonuses and pension contributions to payroll records for the individual directors and check the amounts paid on the bank statements agree with the payroll records.  Review the directors’ contracts and ensure emoluments are consistent with the terms of these contracts.

Question 44

AUDIT PLAN: DIRECTORS’ EMOLUMENTS. What are the valid audit procedures when auditing directors emoluments? (part 3)

Answer 44

 Review board meeting minutes and meetings of any remuneration committee for evidence of any bonuses, fees or other emoluments not disclosed.  Review the cash book for any unusual transactions which suggest undisclosed directors’ emoluments.  Obtain and review returns to tax authorities made by the company on behalf of the directors which detail non-cash benefits. Ensure these are consistent with the benefits disclosed in the financial statements.  Consider the adequacy of disclosure of directors’ emoluments in accordance with applicable accounting standards and local legislation, including the separate disclosure of amounts due to or from directors in respect of directors’ emoluments