SUBSTANTIVE PROCEDURES Flashcards
Substantive Procedures to confirm Non-Current Assets
EXISTENCE
Select a sample of assets from the non-current asset register and physically inspect them. Investigate reasons
if asset is not found.
LO 1: HOW TO PERFORM SUBSTANTIVE PROCEDURES (ASSERTION TESTING APPROACH):
Concept of Areas and Assertions:
here are two types of areas in financial statements i.e.
- Account Balances: i.e. areas appearing in Balance Sheet.
- Classes of Transactions: i.e. areas appearing in Income Statement.
There may be SIX types of misstatement in any area. These misstatements are described by Assertions.
Assertions/Management Assertions/Financial Statement Assertions:
Assertions are representations by management that are embodied in the financial statements. These are used by auditor to assess risks of misstatements, and to obtain evidence.
Assertions about account balances at the period end
- Existence
Recorded assets, liabilities, and equity actually exist.
- Rights and Obligations
Entity holds or controls the rights to assets, and liabilities are obligations of entity.
- Accuracy, Valuation and Allocation
Assets, liabilities, and equity are included in the financial statements at appropriate amounts; and adjustments relating to valuation/allocation have been recorded.
- Completeness
All assets, liabilities and equity that should have been recorded, have been recorded (i.e. there are no unrecorded assets or liabilities).
- Classification
Assets, liabilities and equity have been recorded in the proper accounts.
- Presentation
Assets, liabilities and equity are appropriately aggregated or disaggregated, and disclosures are according to AFRF.
Assertions about classes of transactions and events for the period
- Occurrence
All transactions and events, that have been recorded, have actually occurred and relate to the entity (i.e. there is no overstatement).
- Accuracy
Amounts and other data relating to transactions and events have been recorded appropriately.
- Cut-off
Transactions and events have been recorded in correct accounting period.
- Completeness
All transactions and events, that should have been recorded, have been recorded (i.e. there are no unrecorded income or expenses).
- Classification
Transactions and events have been recorded in the proper accounts.
- Presentation
Transactions and events are appropriately aggregated or disaggregated, and disclosures are according to AFRF.
Substantive Procedures to confirm Non-Current Assets
Existence:
Select a sample of assets from the non-current asset register and physically inspect them. Investigate reasons if asset is not found.
NCA: Accuracy, Valuation and Allocation:
Depreciation and Impairment:
Review Fixed Assets’ Register to ensure depreciation has been charged on all fixed assets (excluding land and fully depreciated assets).
Check whether residual value, useful life/depreciation rate, depreciation method are reasonable (considering industry average, replacement policy, use of asset), and are consistently used.
Recalculate depreciation expense, and impairment working on sample of fixed assets.
Perform analytical procedures i.e. compare ratios of depreciation of non-current assets (for each category) with previous years, and depreciation rates.
Review gain or loss on disposals as indication of possible understatement or overstatement of depreciation expense.
Perform physical inspection to check condition of asset and whether asset is in use.
Obtain understanding of management’s process to identify and record impairment of fixed assets.
NCA Completeness:
- Obtain a schedule of tangible non-current assets, showing cost or valuation, depreciation and carrying amount. Agree opening balance with prior period.
- Obtain fixed assets’ register, reconcile the total with GL/financial statements and investigate any differences.
- Select a sample of assets that physically exist and trace them into the fixed asset register.
NCA Rights and Obligations:
For Land and buildings, inspect legal documents of ownership or lease agreements to ensure they are in the name of company.
For Vehicles, inspect vehicle registration book.
For other assets, examine relevant invoices.
Review legal and bank documents for evidence of any charge/mortgage on assets.
NCA Classification:
Scan ledger to identify unusual entries. If small amounts appear, these may be repair expenses which have been misclassified in fixed asset account.
NCA Presentation and Disclosures:
Ensure that all disclosures required by IAS - 16 have been included in financial statements and are accurate and understandable.
Ensure that fixed assets schedule agrees with figures in financial statements.
Substantive Procedures If there are Additions (i.e. purchased assets)
Obtain list of all fixed asset purchased during the period and agree with fixed assets’ schedule.
- Select a sample of additions and:i. Inspect authorization to purchase fixed assets.ii. Inspect supplier’s invoice to confirm cost. Also ensure that allocation of total expenditure between capital and revenue expenditure are correct.iii. Inspect sale deed and legal documents as evidence of transfer of ownership in the name of company.iv. Physically inspect fixed assets acquired during the year to verify existence.
v. Assess reasonableness of useful life of fixed asset. vi. Ensure that depreciation starts when asset is ready for use. vii. Test calculation of depreciation expense.
Substantive Procedures If there are Disposals
Obtain list of all fixed asset disposed during the period and agree with fixed assets’ schedule.
Select a sample of disposals and:
i. inspect authorization to dispose fixed assets.
ii. agree Sale Price with Invoice, and cash book.
iii. verify that cost and accumulated depreciation has been removed from books of accounts, and fixed assets’ register.
iv. recalculate profit or loss recognized on disposal of assets.
v. Discuss with management possibility of unrecorded disposal of assets.
Substantive Procedures If there is Self-constructed Fixed Asset
Inspect permission of land development authorities.
Physically inspect the construction to confirm that asset has been built and is in use or under construction.
Select a sample of costs capitalized and agree with supporting documentation:
Materials (such as cement, bricks, and fittings) to suppliers’ invoice. Labour costs to approved payroll records/time sheets etc. Overheads to relevant evidence.
Discuss with management policy for capitalization of expenditures on self-constructed asset.
Review the list of expenditures capitalized to ensure that revenue expenses are not capitalized.
Compare budgeted cost with actual cost and investigate significant differences.
Review expert’s assessment of stage of completion, or completion certificate.
Ensure that depreciation starts when asset become ‘available for use’.
Review non-current asset disclosures in the financial statements to ensure they are as per IFRS.
Substantive Procedures if PPE is Revalued
Ensure Competence, Capabilities and Objectivity of expert: (if a valuer is engaged)
(discussed in detail in Chapter # 18)
Evaluate adequacy of work of expert:
(discussed in detail in Chapter # 18)
Ensure that revaluation is properly accounted for and disclosed in financial statements:
- Verify amounts in financial statements with the valuer’s report.
- Ensure that valuation is up-to-date.
- Ensure that entire class of asset has been revalued.
- Ensure that method used to measure Fair Value is consistent.
- Recalculate “revaluation surplus (or loss)”, and “depreciation expenses” and ensure these have been correctly accounted for in books.
- Inspect physically the property to ensure their condition is the same as described in valuation report.
- Ensure that appropriate disclosures have been made in accordance with IAS – 16.
INTANGIBLE NON-CURRENT ASSETS:
Purchased Goodwill
Development Cost
Other Intangibles (e.g. purchase of Brand)
Purchased Goodwill:
Recognition:
i. Review board minutes for approval of acquisition of business.
ii. Check the calculation of purchased goodwill (i.e. difference between cost and fair value of net-assets acquired)
iii. Inspect the purchase agreement and agree cost of acquisition paid to cash book and bank statement.
iv. Inspect due-diligence report for the acquisition, and ensure that all identifiable assets have been included and are reasonably valued.
v. Assess the adequacy of disclosures related to Goodwill in notes to the accounts.
PURCHASED GOODWILL:
Valuation/Impairment:
i. Ensure that carrying amount and fair value are approximately same.
ii. Understand management’s process for recording impairment of goodwill.
iii. Ensure impairment testing has been carried out annually, and correctly recorded.
iv. Evaluate appropriateness of assumptions used in impairment testing (e.g. sales volume, prices, operating cost, growth rates) by comparing with auditor’s own assessment based on our knowledge of client and industry.
v. If necessary, use an expert to evaluate assumptions and methodologies used by company.
vi. Obtain written representation from management that assumptions are reasonable.
Development Cost:
Ensure that development cost is recognized only if criteria is met as required by AFRF. If criteria is not met, it should be expensed out.
Discuss the project/product with management to assess the feasibility of the project/product:
i. review projections and forecast for reasonableness.
ii. assess production and marketing plans and whether a market (or use) actually exists.
iii. consider funding requirements to completion.
iv. obtain representation from management regarding intention to complete the project, and either to use or sell it.
For a sample of costs, inspect supporting documents e.g. development contracts, billing, timesheets, and patents registration.
Review development cost to verify that cost is appropriately classified and does not include research expenses.
Discuss with management and review for possibility of impairment subsequent to recognition.
Other Intangibles (e.g. purchase of Brand):
Inspect board minutes for approval of purchase.
Inspect legal and purchase documents to ensure existence, valuation and right of entity over intangible asset.
Discuss with management the determination of useful life, and check amortization calculation is accurate using client’s policy.
Discuss with management and review for possibility of impairment subsequent to recognition, and calculation of value in use of intangible asset, and check reasonableness of the basis of calculations.
Inventory is an important area because:
-Often it is high value and high risk item.
-Inventory may be stolen, or may become obsolete quickly.
-Inventory may be a complex area requiring need of expert.
-Determination of closing stock may also be a difficult task.
focus of substantive procedures is on Existence and Valuation.
INVENTORY: Valuation and Allocation
Cost of raw materials or the cost of goods purchased for resale:
Test whether valuation method (FIFO or Weighted Average Cost) is consistent with IFRS, Industry and prior year. Also check method is correctly applied.
On sample basis, compare cost of purchased inventory with purchase invoices.
INVENTORY: Valuation and Allocation
Cost of goods manufactured, and work in process:
Obtain schedules showing the break-up of each item in cost of work-in process and finished goods.
- For material used:
Check whether correct quantity of material is used in valuation.
Inspect cost of materials used with purchase invoices. - For Labor used:
Inspect hours worked with time sheets of employees.
Check hourly rates with workers’ records. - Production overheads:
Confirm that only production overheads are included in the valuation.
Confirm that overhead absorption rates are updated.
Auditor will also check Stage of Completion, and Conversion Cost of work in process inventory.
INVENTORY: Valuation and Allocation
Net Realizable Value (NRV):
- Review procedures of management to compare Cost with NRV of each item.
- Inquire client about calculation of NRV of inventory, and check reasonableness of the basis of calculations (e.g. subsequent sale price of inventory).
- Check physical condition of inventory items to identify obsolete and damaged inventory.
- Check amount of sales returns and credit notes issued to customers (particularly after year-end).
- Obtain and inspect aging report of inventory, and review for evidence of slow-moving/obsolete inventory.
- Discuss reason for increase in inventory with management (i.e. difficulty in selling).
For work in process, compare costs incurred to date with selling price minus costs to complete (to be taken from management accounts).
