Chapter 13 Substantive procedures: key financial statement figures Flashcards
1.1 financial statement assertions
when designing substantive procedures, the auditor should consider which financial statement assertions the test needs to address.
1.2 Non-current assets
The auditor should design audit procedures appropriate for tangible and intangible non-current assets as well as investments, depending on the assets held by the client.
The key financial statement assertions to address with suitable audit procedures are:
- Existence (audit procedure is physical verification of assets selected from the non-fixed asset register
- Rights and obligations (audit procedure is inspection of title deeds, vehicle registration, share certificates and purchase invoices)
- Completeness (audit procedure is trace a sample of assets seen in use to the non-current assets register)
- Valuation (audit procedure is to inspect purchase invoices for cost and to inspect surveyor’s report for revaluations. For self-constructed assets agree labour costs to payroll and subcontractor costs to invoices and consider the reasonableness of assumptions wit calculations, also consider appropriateness of depreciation policy, and recalculate the depreciation charge)
3.1 Importance of inventory in the audit
Inventory is a key audit area. Possible reasons for the significance of inventory is:
- Some businesses inventory is highly material
- Its valuation is subjective (lower of cost and NRV)
- It impacts the profit and loss and statement of financial position
The final inventory figures in the accounts are inventory = quantity x value
3.2 Attendance at the inventory count
Attendance at the inventory count is required by ISA 501. It provides evidence about quantity as the auditor performs test counts. They also gather evidence on valuation by identifying items that are damaged or old, as they may be scrapped or sold at a discount.
Before the inventory count:
- Review locations and count instructions
- Consider whether expert help is required
- Review systems of control and internal auditor arrangements
- Arrange to verify any inventory held at third party premises
During the inventory count:
- Observe counts for compliance
- Check cut-off arrangements
- Identify procedures for keeping third party inventory separate
- Perform two way test counts
- Identify slow moving or old inventory that may require impairment
After the inventory count:
- Follow up the sample selected for test counting to check the correct quantity has been included in the final inventory listing.
3.3 Audit procedures
The key financial statement assertions to address with suitable audit procedures are:
Assertion Audit procedures
Existence Take a sample of items already counted by the client from the count sheets, and agree to the number of items in the warehouse
Rights and obligations Seek confirmation from third parties about inventory held on their behalf at the client, or held at their premises for the client
Completeness Take a sample of items in the warehouse and count them, then agree to the client’s to the client’s count sheets
Valuation
To obtain evidence over cost:
Agree costs to purchase invoice, for inventory manufactured by the company: agree materials costs to invoice, agree labour costs to payroll and evaluate the reasonableness of assumptions underlying overhead calculations, and reperform the calculations.
To obtain evidence over net realisable value:
Inspect post yearend sales invoices for evidence of actual selling prices. For items not sold by the time of the audit, inspect order books/price lists. At the inventory count, look for old or damaged items which may indicate obsolescence. Review the aged inventory listing to identify old or slow-moving items and discuss the need for impairment with client management.
4.1 Receivables: audit procedures
The audit of receivables usually focuses on whether the customer agrees with the recorded balance, and whether the debt is likely to be paid. The key assertions to address with audit procedures are:
Assertion Audit procedures
Existence, rights, and obligations: Obtain direct confirmation of receivables balances from customers
valuation: For a sample of receivables selected from the receivables ledger, inspect the post end bank statements to identify cash received from customers. Discuss the allowance for doubtful debts with client management, evaluate the reasonableness of their assumptions and reperform any calculations.
4.2 Customer confirmations
ISA 505 provides guidance to auditors where they wish to use external confirmation as a form of audit evidence.
How confirmations work:
Auditor prepares confirmation requests, client sends requests to customers, customers send replies direct to the auditor.
Different types of customer confirmation:
Positive confirmations encourage definite replies from those contacted. Negative confirmations only request a reply if the balance is disputed, but a lack of response could mean the customer ignored or did not see the request. Negative confirmations should only be used where:
- The risk of management is low
- Controls are operating effectively
- A large number of small balances are involved
- There is no reason to believe that customers will disregard the request
5.1 Accounting knowledge – bank and cash
The key assertions to address with suitable audit procedures are:
Assertion Audit procedures
Valuation Agree reconciling items in bank rec to the post year end bank statements
Rights and obligations Confirm bank balances directly with the bank
Existence Count material cash balances held by the client and confirm bank balances directly with the bank
5.3 Bank confirmations
Obtaining direct confirmation from the bank provides reliable audit evidence over bank balances, this is similar to obtaining customer confirmation. The auditor will prepare a confirmation request, the client signs and sends to the bank (bank will require written authority to disclose from the client) and then the bank sends confirmation direct to the auditor.
The form and content of the bank confirmation letter may vary, in addition the auditor may seek confirmation of:
- Loans and overdraft facilities and terms
- Contingent liabilities (for example guarantees given)
- Securities belonging to the client that are held in safe custody by the bank
6.1 payables
The key risk is payables are understated. This means we consider the concept of directional testing:
- Selecting a sample of payables balances in the payables ledger will not allow you to identify missing balances
- Instead, it is important to select a reciprocal population
Assertion Audit procedures
Completeness Obtain a sample of supplier statement reconciliations performed by the client and test the rec items. Inspect post year end bank statements and identify payments, trace these to GRNs and if they relate to pre year end receipts check they are included in the payables balance
7.1 Long term liabilities
Long term liabilities include debentures, loan stock and other loans repayable at a date more than a year after the year end. The accounts disclose the split between current and long term liabilities.
Assertion Audit procedures
Completeness Obtain direct confirmation from lenders of balances, interest and any security held against the loan. Inspect board minutes for evidence of new loans and confirm repayments are in accordance with the loan agreements
Presentation and disclosure Recalculate the split of the loan between current and long term. Inspect the financial statements disclosure note for adequacy
Accuracy and cut off Verify interest charged for the period and the adequacy of accrued interest
8.1 Statement of profit or loss items
The key financial statement assertion is completeness. When auditing items in the profit or loss, the auditor is faced with a large volume of transactions like sales or purchases, the most efficient audit approach is a combinations of tests of control, analytical procedures (for example comparison of prior year and budget figures, month by month review, proof in total for items like payroll) and some tests of detail.
9.1 Matters which should be referred to a senior member of staff
Matters which should be referred to a senior member of staff include conclusions, indications of possible money laundering, exceptional items, unusual accounting entries and issues requiring further discussions with the client.
