Chapter 8 - Procedures

Question 1

Directional testing

Answer 1

Auditors primarily test debit entries for overstatement (assets and expenses) and credit entries for understatement (liabilities and income)

Question 2

Bank and cash

Answer 2

Key assertions are existence and valuation.
The auditor relies mainly on the back confirmation letter and the bank reconciliation.

1. Obtain the company’s bank reconciliation and cast to ensure arithmetical accuracy. Agree the cash book figure to the financial statements: valuation.
2. Obtain a bank confirmation letter from the company’s bankers: existence, rights and obligations.
3. Agree the reconciliation’s balance per the cash book to the year end cash book: valuation.
4. Agree the balance per the bank statement to an original year end bank statement and also to the bank confirmation letter: valuation.
5. Trace all of the outstanding lodgements to the pre year end cash book, post year end bank statement and also to paying in book pre year end: valuation, existence.
6. Trace all unpresented cheques through to pre year end cash book and post year end statement. Obtain explanations from management for any unusual amounts or significant delays: valuation, completeness.
7. Examine any old unpresented cheques to assess if they need to be written back into the purchase ledger as they are no longer valid to be presented: valuation, completeness.
8. Examine the bank confirmation letter for details of any security provided by the company or any legal right of set-off as this may require disclosure: presentation.
9. Review the cash book and bank statements for any unusual items or large transfers around the year end (window dressing): completeness, existence.
10. Count the petty cash at year end and agree the total to the balance included in the financial statements: valuation, existence.

Question 3

Non-current liabilities

Answer 3

Key assertion is completeness.

Additional procedures the auditor needs to perform in relation to loan payables include:

1. Obtain a breakdown of all loans outstanding at year end, cast to verify arithmetical accuracy and agree the total to the financial statements: completeness.
2. Agree the balance outstanding to the bank confirmation letter: valuation, rights and obligations.
3. Inspect bank confirmation letters for any loans listed that have not been included in the financial statements: completeness.
4. Inspect financial statements for disclosures of interest rates and the split of the loan between current and non-current: allocation, presentation.
5. Inspect the loan agreement for restrictive covenants and determine the effect of any loan covenant breaches: allocation, presentation. If breached, the loan maybe immediately repayable and therefore be included as a current liability.
6. Inspect the cash book for loan repayments made: existence, valuation.
7. Recalculate the interest charge and any interest accrual in accordance with terms with the loan agreement: accuracy of finance costs in the statement of profit or loss, completeness of accruals.

Question 4

Non-current assets

Answer 4

Key assertions are existence, valuation, completeness and rights and obligations.

Auditing tangible non current assets requires the auditor to obtain sufficient appropriate evidence over many areas.

1. Existing assets.
2. Additions.
3. Disposals and the related profit/loss in the statement of profit or loss.
4. Depreciation.
5. Revaluations.
6. Related disclosures (property, plant and equipment note, depreciation policies, useful economic lives, revaluations and assets under finance leases).

Procedures
1. Obtain the non-current asset register, cast and agree the total to the financial statements: verifies completeness.

2. Select a sample of assets from the non-current asset register and physically inspect them: verifies existence.
3. Select a sample of assets visible at the clients premises and inspect the asset register: verifies completeness.
4. Cast the non-current asset register totals and sub-totals to ensure arithmetical accuracy: verifies valuation.
5. Inspect assets for condition and usage to identify signs of impairment: verifies valuation.
6. For revalued assets, inspect the valuer’s report and agree the amount stated to the amount included in the general ledger and the financial statements: verifies valuation.
7. Obtain a breakdown of additions, cast the list and agree to the non-current asset register: verifies completeness.
8. Select a sample of additions and agree cost to supplier invoice: verifies valuation.
9. Inspect the list of additions and confirm that they relate to capital expenditure items rather than repairs and maintenance: verifies existence.
10. Inspect the repairs and maintenance account in the general ledger for items of a capital nature: verifies completeness.
11. Inspect supplier invoices, tile deeds and registration documents to ensure in the name of the client: verifies rights and obligations.
12. If assets have been constructed, obtain an analysis of costs incurred, cast for arithmetical accuracy and agree a sample of costs to supporting documentation: verifies valuation.

Disposals
1. Obtain a breakdown of disposals, cast and agree all removed from the non-current asset register: verifies existence.

2. Select a sample of disposals and agree sale proceeds to supporting documentation such as sundry sales invoices: verifies accuracy of profit on disposal.
3. Recalculate the profit/loss on disposal and agree to the statement of profit or loss: verifies accuracy of profit on disposal.

Depreciation
1. Inspect the capital expenditure budgets for next few years to assess the useful economic lives of plans to replace assets.

2. Recalculate the depreciation charge for a sample of assets to verify arithmetical accuracy.
3. Inspect the financial statement disclosure of the depreciation charges and policies in the draft financial statements and compare to prior year to ensure consistency.
4. Recalculate the depreciation charge for revalued assets to ensure the charge is based on the new carrying value.
5. Review profits and losses on disposal of assets disposed of in the year to assess the reasonableness of the deprecation policies.
6. Compare depreciation rates to companies with the same type of assets.
7. Perform a proof in total calculation for the depreciation charged for each category of assets and discuss with management any significant fluctuations.

Development costs
Key assertion is existence. Only capitalised as an intangible asset if all criteria have been met.

1. Obtain a breakdown of costs capitalised, cast for mathematical accuracy and agree to the amount included in the financial statements: verifies valuation.
2. For a sample of costs, agree to invoices or time sheets: verifies valuation.
3. Inspect board minutes for any discussions relating to the intended sale or use of the asset: verifies existence.
4. Discuss the details of the project with management to evaluate compliance with IAS 38 Intangible Assets criteria: verifies existence.
5. Inspect project plans and other documentation to evaluate compliance with IAS 38 Intangible Assets criteria: verifies existence.
6. Inspect budgets to confirm financial feasibility: verifies existence.

Question 5

Intangible non-current assets

Answer 5

Development costs
Key assertion is existence. Only capitalised as an intangible asset if all criteria have been met.

1. Obtain a breakdown of costs capitalised, cast for mathematical accuracy and agree to the amount included in the financial statements: verifies valuation.
2. For a sample of costs, agree to invoices or time sheets: verifies valuation.
3. Inspect board minutes for any discussions relating to the intended sale or use of the asset: verifies existence.
4. Discuss the details of the project with management to evaluate compliance with IAS 38 Intangible Assets criteria: verifies existence.
5. Inspect project plans and other documentation to evaluate compliance with IAS 38 Intangible Assets criteria: verifies existence.
6. Inspect budgets to confirm financial feasibility: verifies existence.

Other Intangible assets
1. Inspect purchase documentation for purchased intangible assets: verifies existence, rights and obligations and valuation.

2. Inspect specialist valuer’s report and agree amount stated to the amount included in the general ledger and the financial statements: verifies valuation.

Question 6

Inventory

Answer 6

Key assertions are existence, valuation, completeness and rights and obligations.

The main source of inventory is the year end inventory count.
The inventory count is the responsibility of the client, the auditor does not perform the count.

Question 7

Before inventory count

Answer 7

1. Contact the client to obtain a copy of the inventory count instructions to understand how the count will be conducted and assess the effectiveness of the count process.
2. Inspect prior year working papers to understand the inventory count process and identify and issues that would need to be taken into account this year.
3. Book audit staff to attend the inventory counts.
4. Ascertain whether any inventory is held by third parties and to gather sufficient appropriate evidence.
5. Consider the need for using an expert to assist in valuing the inventory being counted.
6. Send a letter requesting direct confirmation of inventory balances held at year from any third party warehouse providers used regarding quantities and condition.

Question 8

During inventory count

Answer 8

Tests of controls
Observe the count to ensure that the inventory count instructions are being followed.
- Non-warehouse staff performing and managing the count.
- Sections of inventory being tagged or marked as counted to prevent double counting.
- Count sheets written in pen rather than pencil.
- No movements of inventory during the count.
- Sequentially numbered count sheets and a sequence check performed once the count is complete.
- Teams of 2 people performing the count.
- Count sheets show the description of the goods but do not show the quantities expected to be counted.
- Damaged/ obsolete items must be separately identified so they can be valued appropriately.

Substantive procedures
1. Select a sample of items from the inventory count sheets and physically inspect the items in the warehouse: verifies existence.

2. Select a sample of physical items from the warehouse and trade to the inventory count sheets to ensure that they are recorded accurately.
3. Enquire whether goods held on behalf of third parties are segregated and recorded separately: verifies rights and obligations.
4. Inspect the inventory being counted for evidence of damage or obsolescence that may affect the NRV: verifies valuation.
5. Record details of the last deliveries prior to year end. This information will be used in final audit procedures to ensure no further amendments have been made thereby overstating or understating inventory: verifies completeness and existence.
6. Obtain copies of inventory count sheets at the year end inventory count.
   Check against final inventory listing after the count: verifies completeness and existence.
7. Attend the inventory count if one performed at the third party warehouses: verifies completeness and existence.

Question 9

After inventory count

Answer 9

1. Trace the items counted during the inventory count to the final inventory list to ensure it is the same as the one used at the year-end and to ensure that any errors identified during counting procedures have been rectified: verifies completeness.
2. Cast the list to ensure arithmetical accuracy and agree totals to financial statement disclosures: verifies completeness.
3. Inspect purchase invoices for a sample of inventory items to agree their cost to verify valuation.
4. Inspect purchase invoices for the name of the client to verify rights.
5. Inspect post-year-end sales invoices for a sample of inventory items to determine if the NRV is reasonable. This will also assist if determining if inventory is held at the lower of cost and NRV: verifies valuation.
6. Inspect the ageing of inventory items to identify old/slow- moving amounts that may require an allowance and discuss these with management: verifies valuation.
7. Recalculate WIP and finished goods valuations using payroll records for labour costs and utility bills for absorption: verifies valuation.
8. Trace the good received immediately prior to the year-end to year-end payables and inventory balances: verifies completeness and existence.
9. Trace goods despatched immediately prior to year end to the nominal ledgers to ensure they are not included in inventory and revenue has been recorded: verifies completeness and existence.
10. Calculate inventory turnover/days ratio and compare this to prior year to assess whether inventory is being held longer and therefore requires an allowance to bring the value down to the lower of cost and NRV: verifies valuation.
11. Calculate gross profit margin and compare this to prior year, investigate any significant differences that may highlight an error in cost of sales and close of inventory: verifies valuation.

Question 10

Inventory held by third parties

Answer 10

1. Where a third party holds inventory on behalf of the client, obtain external confirmation from the third party of the quantity and condition of the goods to confirm rights and valuation.
2. If the goods held by the third party are auditor should attend the inventory count to verify existence of the inventory.
3. The auditor can also obtain a report from the third party’s auditors confirming the reliability of the internal controls at the third party.

Question 11

Standard costs

Answer 11

1. Obtain the breakdown of the standard cost calculation and agree a sample of costs to inovices.
2. Enquire of management the basis for the standard costs and how often they are updated to reflect current costs.
3. Inspect the variance account and assess the level of variance for reasonableness. Discuss with management any significant variances arising.

Question 12

Receivables

Answer 12

1. Obtain an aged receivables listing, cast to verify arithmetical accuracy and agree the total to the financial statements.
2. Agree the sales ledger control account with the sales ledger list of balances: verifies completeness and existence.
3. Select a sample of year-end receivable balances and agree back to valid supporting documentation of GDN and sales order: verifies existence.
4. Inspect after date cash receipts and follow through to pre year-end receivable balances: verifies valuation, rights and obligations and existence.
5. Select a sample of GDNs before and just after the year end and follow through to the sales invoice to ensure they are recorded in correct accounting period: verifies completeness and existence.
6. Perform a positive receivables circularisation of a representative sample of Murray Co’s year end balances for any non-replies with Murray Co’s permission, send a reminder letter to follow-up: verifies existence and rights and obligations.
7. Inspect the aged receivables report to identify any slow moving balances, discuss these with the credit control manager to assess whether an allowance or write down is necessary: verifies valuation and allocation.
8. Inspect customer correspondence in respect of any slow moving/ aged balances to assess whether there are any invoices in dispute: verifies existence and rights and obligations.
9. Inspect board minutes of Murray Co to assess whether there are any material disputed receivables that may require write off: verifies existence and rights and obligations.
10. Inspect the sales ledger for any credit balances and discuss with management whether these should be reclassified as payables: verifies existence of receivables and completeness of payables.
11. Inspect a sample of post year-end credit notes to identify any that relate to pre year-end transactions to ensure that they have not been included in receivables: verifies existence.
12. Calculate average receivable says and compare to prior year, investigate any significant differences: verifies completeness and valuation.

Question 13

Prepayments

Answer 13

1. Inspect bank statements to ensure payment has been made
2. Inspect invoices to ensure payment relates to goods or services not yet received.
3. Recalculate the amount prepaid to confirm mathematical accuracy.
4. Compare prepayments with the prior year to identify any missing items or any new prepayments which require further testing.

Question 14

Payables and accruals

Answer 14

1. Obtain a listing of trade payables from the purchase ledger, cast to verify accuracy and agree to the general ledger and the financial statements.
2. Reconcile the total of purchase ledger accounts with the purchase ledger control account.
3. Obtain supplier statements and reconcile these to the purchase ledger balances. Investigate any reconciling items.
4. Inspect after date payments if they relate to the current year then follow though to the purchase ledger or accrual listing.
5. Inspect invoices received after the year end to ensure no further items need to be accrued.
6. Enquiry of management their process for identifying GRNI or logged in the purchase ledger and ensure it is reasonable.
7. Select a sample of GRNs before year end and follow through to inclusion in the year-end payables balance.
8. Select a sample of payable balances and perform a trade payables circularisation, follow up any non replies and any reconciling items between balance confirmed and trade payables.
9. Inspect the purchase ledger for any debit balances for any significant amounts, discuss with management and consider reclassification as current assets.
10. Compare the list of trade payables and accruals against prior year list to identify any significant omissions.
11. Calculate the trade payable days and compare to prior years, investigate any significant differences.
12. Obtain the list of accruals from the client, cast it to confirm mathematical accuracy and agree to the general ledger and the financial statements.
13. Recalculate a sample of accrued costs by reference to contacts and payments schedules.
14. Inspect invoices received post year end to confirm the actual amount and assess whether the accrual is reasonable.
15. Compare the accruals this year to last year to identify any missing items or unusual fluctuation in amount and discuss with management.

Question 15

Provisions

Answer 15

1. Obtain a breakdown of the items to be provided for, cast it to confirm arithmetical accuracy and agree the figure to the financial statements.
2. Enquire with the directors or inspect relevant supporting documentation to confirm a present obligation exists at the year end.
3. Inspect relevant board minutes to ascertain whether payment is probable.
4. Recalculate the provision and agree components of the calculation to supporting documentation.
5. Inspect post year-end bank statements to identify whether any payments have been made, compare actual payments to the amounts provided to assess whether the provision is reasonable.
6. Obtain a written representation from management that they believe the provision is valued appropriately and is complete.
7. Obtain confirmation from client’s lawyer about the likely outcome and chances of payment.
8. Inspect correspondence received from the lawyer regarding the legal provision to assess whether a provision should be recognised and if so whether the amount is adequate.
9. Inspect the financial statement disclosure of the provision to ensure compliance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Question 16

Share capital

Answer 16

1. Agree authorised share capital and nominal value disclosures to underlying shareholding agreements/statutory constitution documents.
2. Inspect cash book for evidence of cash receipts from share issues and ensure amounts not yet received are correctly disclosed as share capital called up not paid in the financial statements.
3. Inspect board minutes to verify issue of share capital during the year.

Question 17

Dividends

Answer 17

1. Inspect board minutes to agree dividends declared before the year end.
2. Inspect bank statements to agree dividends paid before the year-end.
3. Inspect dividend warrants to agree dividend payment.

Question 18

Director’s emloments

Answer 18

1. Obtain and cast a schedule of director’s remuneration split between wages, bonuses, benefits, pension contributions and other remuneration and agree to financial statement disclosures.
2. Inspect payroll records and agree wages, bonuses and pension contributions.
3. Inspect bank statements to verify the amounts actually paid to directors.
4. Inspect board statements for discussion and approval of directors’ bonus announcements or other additional remuneration.
5. Obtain a written representation from directors that they have disclosed directors’ remuneration to the director.

Question 19

Reserves

Answer 19

1. Agree opening reserved to prior year closing revenues and reconcile movements.
2. Agree movements in reserves to supporting documentation.

Question 20

Payroll

Answer 20

1. Agree the total wages and salaries expense per the payroll system to the general ledger and the financial statements.
2. Cast the monthly payroll listings to verify the accuracy of the payroll expense.
3. Recalculate the gross and net pay for a sample of employees and agree to the payroll records.
4. Re-perform calculation of statutory deductions to confirm whether correct deductions for this year have been included within the payroll expense.
5. Select a sample of joiners and leavers, agree their start/leaving date to supporting documentation, recalculate that their first/last pay packet was accurately calculated and recorded.
6. For salaries, agree the total net pay per the payroll records to the bank transfer listing of payments and to the cash book.
7. For wages, total cash withdrawn for wage payments quotes to the weekly wages paid plus any surplus cash subsequently banked.
8. Agree the year-end tax liabilities to the payroll records and subsequent payment to the post year-end cash book.
9. Agree the individual wages and salaries per the payroll to the personnel records and records of hours worked per clocking in cards.

Question 21

Payroll analytical procedures

Answer 21

1. Perform a proof in total wages and salaries, incorporating joiners and leavers and the pay increase. Compare to actual wages and salaries in the financial statements and investigate any significant differences.
2. Compare the payroll figure for this year to last year to identify any unusual fluctuations and discuss them with management.

Question 22

Revenue

Answer 22

1. Inspect a sample of GDNs before and after year end and ensure they have been recorded in the correct period.
2. Recalculate discounts and sales tax applied for a sample of large sales invoices.
3. Select a sample of customer orders and agree these to the despatch notes and sales novices through to inclusion in the sales ledger.
4. Inspect credit notes issued after year end, trace to GDN and invoice and ensure the sale has been reversed.

Question 23

Revenue analytical procedures

Answer 23

1. Compare revenue against prior year and investigate any significant fluctuations.
2. Compare revenue with budget/forecast and investigate any significant fluctuations.
3. Calculate the gross profit margin and compare to prior year. Investigate any significant differences.

Question 24

Purchases and other expenses

Answer 24

1. Inspect GRNs before and after the year end and ensure they have been recorded in the correct period.
2. Recalculate discounts and sales tax applied for a sample of large purchase invoices.
3. Select a sample of purchase orders and agree to GRNs and purchase through to inclusion in the purchase ledger.

Question 25

Purchases and other expenses analytical procedures

Answer 25

1. Compare expenses for each category year on year and investigate any significant fluctuations.
2. Compare expenses against budget and investigate any significant fluctuations.
3. Calculate gross profit margin and compare with prior year to identify any possible misstatement of purchases. Discuss any significant movement with management.
4. Calculate operating profit margin and compare with prior year, investigate any significant fluctuations.
5. Inspect purchase invoices for a sample of purchases/expenses in the ledger for the amount, name of the client and description of the goods.

Question 26

Accounting estimates

Answer 26

For each estimate in the financial statements, the auditor must also

1. Enquire of management how the accounting estimate is made and the data on which it is based.
2. Determine whether whether events occurring up to the date of the auditor’s report provide audit evidence regarding the accounting estimate.
3. Review the method of measurement used and assess the reasonableness of assumptions made.
4. Test the operating effectiveness of the controls over how management made the accounting estimate.
5. Develop an expectation of the possible estimate or a range of amounts to evaluate management’s estimate.
6. Review the judgements and decisions made by management in the making of accounting estimates to identify whether there are indicators of possible management bias.
7. Evaluate overall whether the accounting estimates in the financial statements are either reasonable or misstated.
8. Obtain sufficient appropriate audit evidence about whether the disclosures in the financial statements are either reasonable or misstated.
9. Obtain sufficient appropriate audit evidence about whether the disclosures in the financial statements related to accounting estimates and estimation uncertainty are reasonable.
10. Obtain written representations from management and where e charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable.