CHAPTER 13

The audit of other assets and

liabilities
EXAM FOCUS
The auditor m ust give an opinion on the financial statem ents as a whole, so he must investigate
the figures for receivables, cash, trade payables, tax payable etc.

Exam questions tend to cover topics where a specific audit test can be applied, eg circularising
debtors or obtaining a bank certificate.

SYLLABUS AND STUDY GUIDE COVERAGE

This chapter covers the following elements of the ACCA study guide:

15 ,QWHUQDO&RQWURO9,²%DQNDQG&DVK

¨ Describe, illustrate and analyse how internal control systems over the bank and
cash transaction cycle operate in both large and small entities.

¨ Describe and illustrate the use by auditors of internal control checklists for the
bank and cash transaction cycle.

¨ Describe and tabulate tests of control of bank and cash for inclusion in a work
program.

¨ Explain and illustrate how structural and operational weaknesses in bank and cash
systems should be reported to management and how recommendations should be
made.

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¨ Describe and tabulate for inclusion in a w ork program the substantive procedures
used in obtaining evidence in relation to receivables and prepayments, current
liabilities and accruals, and bank and cash, and the related income statement
entries.

¨ Explain the purpose of substantive procedures in relation to financial statement

assertions concerning receivables and prepayments (including direct
confirmation), current liabilities and accruals (including supplier statement
reconciliations), and bank and cash (including bank confirmation reports).

In order to cover these elements the follow ing topics are included:

Debtor circularisation letters

Bank reports for audit purposes

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Other assets and liabilities

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 Chapter 13 The audit of other assets and liabilities

1 The audit of accounts receivable

1.1 Tests relating to ownership and existence
The main audit procedures are as follows.

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¨ Examination of balances and post balance sheet date settlements which confirm that the
debt did exist at the balance sheet date.

¨ Good credit control procedures over receivables ledger eg, agreement of control accounts,
debt recovery procedures.

¨ Reading correspondence with debtors.

1.2 Tests relating to valuation

Two important audit procedures should be used.

¨ Review ing and testing the calculation of any general allowance for doubtful debts.

¨ Analytical review procedures: examining income analyses, comparative figures for sales
and receivables, and key ratios (eg, gross profit, quick assets and receivables collection
period).

1.3 Tests relating to presentation

Receivables should be presented at net realisable value (ie, net of any allowance for doubtful
debts).

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disclosed under payables instead).

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however, requires the total figure of receivables to be analysed in a note between:

¨ amounts falling due to be collected w ithin one year, and

¨ amounts falling due to be collected after one year.

1.4 Other substantive tests on accounts receivable

The following additional procedures should be considered.

¨ ([DPLQLQJDVDPSOHIURPWKHUHFHLYDEOHVOHGJHUZLWKDQ´DJHGµOLVWRIEDODQFHVQRWLQJWKH
composition of the debt and w hether it has been paid after the balance sheet date.

¨ Checking casts and agreeing the total w ith control account balances.

¨ 9HULI\LQJ´FXWRIIµSURFHGXUHVDQGWKHDOORZDQFHIRUFUHGLWQRWHV DQGRU DFFUXDO IRU VDOHV

invoiced late.

¨ Vouching bad debt write-offs with suitable authority.

¨ Review ing bad debt policy for consistency with previous years.

¨ Examining a sample of bad debts in light of the allowance in order to determine that the
policy has been complied with.

¨ Review ing any significant balances that are in arrears but have not been regarded as bad
debts.

¨ Investigating any significant credit balances to establish the cause. Note any instances of

191
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PLVVLQJLQYRLFHVDQGGUDZPDQDJHPHQW·VDWWHQWLRQWKHUHWR

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 Chapter 13 The audit of other assets and liabilities

1.5 Analytical review

Analytical review identifies overall trends and relationships between sets of figures, in this
case figures in the financial statements.

It is a useful tool for identifying areas where m ore w ork is required. Such areas would be
where the trends are fluctuating or relationships are difficult to find. The auditor must review
the relationship between income, trade receivables and other related items by taking account of
the following matters.

¨ Significant ratios (eg, gross profit/sales, current assets/current liabilities, quick

DVVHWVFXUUHQWOLDELOLWLHVUHFHLYDEOHVLQWHUPVRIDZHHN·VVDOHV 

¨ Budgets for the year under review and subsequent years - note variances and causes.

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¨ Interim accounts for the succeeding period, noting collection of debts, sales and profit
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OHGJHU DQG DIWHU REWDLQLQJ WKH FOLHQW·V SHUPLVVLRQ ZULWLQJ GLUHFW WR WKH FXVWRPHU WKH GHEWRU
in order to confirm that the balance is correct.

A circularisation letter may take the following format.

Audit confirmation

Will you please return the attached slip to our auditors, Messrs Pears, Cross, Brannigan & Company of
131/133 Dutchman Avenue, W21 6EW indicating whether or not you agree the enclosed account by
deleting the line which does not apply.

In the event of disagreement please give details. A stamped addressed envelope is enclosed for your
reply.

««««««««««««

To: Messrs Pears, Cross, Brannigan & Company, 131/133 Dutchman Avenue, London W21 6EW

Audit confirmation of balance due to

Solti Potato Crisps plc at 31 March 20X4

Please delete as necessary:

We confirm that the balance due from us to the above company at the above date was $ ..........

According to our records the amount due from us to the above company was $..........

Yours faithfully

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because customers may not reply at all, and even if they do their balances may disagree with
WKHFOLHQW·VILJXUHV

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Options for follow-up procedures are as follow s.

¨ Second letter if no reply is received.

¨ Use other methods of verifying the debt, such as matching to cash receipts or verifying that
the sale has taken place by matching invoices to signed delivery notes.

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Such differences normally arise because of cash or invoices in transit, but may also stem
from miscellaneous causes such as an unrecorded discount.

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$GHEWRUV·FLUFXODULVDWLRQLVDQLPSRUWDQWDUHDEHFDXVHWKHUHKDYHEHHQSUHYLRXVH[DPTXHVWLRQV
purely on this one test.

If this is the case, you will not gain anywhere near the available 20 marks by merely describing a
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carried out. In other words, what do you do, as an auditor, if your initial test does not quite go
according to plan?

ISA 505 differentiates between a positive and a negative circularisation.

A positive circularisation is like the one described above and is the usual approach.

In a negative circularisation all customers are deemed to agree the balance unless they write
back and state the contrary.

A negative circularisation is not particularly reliable third party evidence but it is a valid point to
include in an answer. You can describe the test and then criticise it, providing your answer with
both volume and relevance.

1.8 Prepayments
Prepayments generally arise w hen the enterprise makes advance payments in respect of
expenditure, such as rent, property taxes, insurance and licence fees.

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¨ The relevant voucher: inspection of a payment demand or rent invoice w ill provide
adequate evidence of the am ount to be carried forward.

¨ The analysed schedule prepared by the client show ing the composition of the item debited
in the income statement.

¨ The relevant comparative figure from last year: any significant variation should be
investigated as this might provide evidence of understatement of expenditure.

2 The audit of cash and bank balances

2.1 Cash balances
The audit objectives in this case are to ensure that:

¨ petty cash floats and other amounts in hand exist and are intact.

¨ FDVKLQWUDQVLWDULVLQJWKURXJKWKHRSHUDWLRQRIWKHFRPSDQ\·VVDOHVF\FOHLVLQWDFWDQGFDQ
be verified (cash in transit is cash that has been collected through cash sales, and has not
yet been banked).

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 Chapter 13 The audit of other assets and liabilities

2.2 Petty cash

This is the m ost portable of all the assets of the enterprise and it is also the m ost susceptible to
misappropriation. It is therefore prudent to review the internal controls in existence over this
asset before planning the audit routines to verify this item.

Internal controls may include the follow ing.

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be involved in recording or authorising functions, or be responsible for replenishing the
petty cash.

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suitable insurance arrangements.

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and countersigned before being disbursed. The form should be cancelled after payment.
All floats should be controlled by an imprest system. There should be fidelity insurance for
staff who handle cash.

Verification of the petty cash balance is a desirable audit procedure in order to provide
reassurance that funds exist at the balance sheet date. W here small balances exist (eg, expense
floats held by employees), their existence can be validated by certificate.

However, w here petty cash is a material item or w here the enterprise is a cash taking business
(eg, a hotel) the year end count is essential. W here the division of duties is unsatisfactory, the
validation of the petty cash balance by means of a count is desirable.

Features of the count include the follow ing.

¨ Simultaneous counting of all cash floats, as far as possible, in order to reduce the risk of
substitution of funds to cover up duplications.

¨ Identifying irregular practices, such as cheque cashing for staff or providing financial
assistance w ith IOUs.

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counting all cash-in-hand.

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in case any shortfall should have occurred, so that suspicion is not directed to the auditor.

2.3 Cash in transit

As stated earlier, any cash taking business (such as hotels, department stores etc) will have
material amounts of cash in transit at the end of the financial period, and the audit procedures
will need to be planned around clear written instructions for the verification process. Pertinent
points are as follows.

¨ Audit planning for cut-off procedures ie, identifying the point w hen the cash taking
activity ceases.

¨ Supervisory controls over cash handling eg, overnight safe deposit; adequate insurance
FRYHUGLYLVLRQRIGXWLHVEHWZHHQ´FDVKLQJXSµVXSHUYLVLQJDQGWKHSUHSDUDWLRQRISD\LQJ
in books; and prompt banking at the first available opportunity.

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¨ Reconciliation procedures by listing sales dockets, verifying cash register totals etc.

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2.4 Bank balances

The auditor should check on the following internal controls.

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separate from those concerned with custodial functions, w ho should be, in turn, remote
from the official who reconciles the bank account.

¨ Reconciliations are regularly reviewed by some responsible official w ho has no part in

preparing them.

Audit tests should be as follows.

¨ Tracing cash payments and receipts to pass sheets, noting that cheques are entered in
sequence and appear to be presented without unreasonable delay.

¨ Tracing all contra items, stopped items, cancelled cheques, and noting the authority for the
stopped or cancelled item s.

¨ Vouching transfers to the petty cash book and to other bank accounts.

¨ Testing casts and cross-casts of cash book.

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¨ Verifying bank pass sheet balances w ith a bank report for audit purposes.

2.5 Bank reports for audit purposes

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IURP WKH HQWHUSULVH·V EDQNHUV GLUHFWO\ WR WKH DXGLWRU  ,6$  External confirmations discusses
the procedures to be followed.

The standard form of letter in the U K is set out below as an illustrative example.

(a) The form of the letter should not be amended by the auditor, because it has been
agreed by the banking industry.

(b) The letter is sent out in duplicate, so that the bank can keep a copy of their answer if
they so wish.

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 Chapter 13 The audit of other assets and liabilities

Specimen bank confirmation request letter

«««««««««%DQNSOF
(Bank address)

Dear Sirs

In accordance with the agreed practice for provision of information to auditors, please forward
information on our mutual client(s) as detailed below on behalf of the bank, its branches and
subsidiaries. This request and your response will not create any contractual or other duty with us.

COMPANIES OR OTHER BUSINESS ENTITIES

(attach a separate list if necessary)

«««««««««««««««««/WG

«««««««««««««««««/WG

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$8',7&21),50$7,21'$7(«««««««

Information required Tick

Standard
Trade finance
Derivative and commodity trading
Custodian arrangements
Other information (see attached)

The Authority to Disclose Information signed by your customer is attached/already held by you.*
Please advise us if this Authority is insufficient for you to provide full disclosure of the information
requested.

7KHFRQWDFWQDPHLV««««««««««« 7HOHSKRQH«««««««««««««

Yours faithfully

*Delete as appropriate

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Standard request for information

1 Account and balance details

¨ Give full titles of all bank accounts including loans (whether in sterling or another currency)
together with their account numbers and balances. For accounts closed during the 12
months up to the audit confirmation date give the account details and date of closure.

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account is in a trade name.

¨ State if any account or balances are subject to any restriction(s) whatsoever. Indicate the
nature and extent of the restriction eg, garnishee order.

2 Facilities

Give the following details of all loans, overdrafts, and associated guarantees and indemnities:

¨ term
¨ repayment frequency and/or review date
¨ details of period of availability of agreed finance ie, finance remaining undrawn
¨ detail the facility limit.

3 Securities

With reference to the facilities detailed in (2) above give the following details:

¨ Any security formally charged (date, ownership and type of charge). State whether the
security supports facilities granted by the Bank to the customer or to another party.

Note: give details if a security is limited in amount or to a specific borrowing or if to your knowledge there
is a prior, equal or subordinate charge.

¨ Where there are any arrangements for set-off of balances or compensating balances eg, back-
to-back loans, give particulars (ie, date, type of document and accounts covered) of any
acknowledgement of set-off, whether given by specific letter of set-off or incorporated in
some other document.

4 Additional banking relationships

State if you are aware of the customer(s) having any additional relationships with branches or
subsidiaries of the Bank not covered by the response. Supply a list of branches etc.

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 Chapter 13 The audit of other assets and liabilities

Request for trade finance information

1 Trade finance

Give the currencies and amounts of the following:

(a) Letters of credit.

(b) Acceptances.
(c) Bills discounted with recourse to the customer or any subsidiary or related party of the
customer.
(d) Bonds, guarantees, indemnities or other undertakings given to the Bank by the customer in
favour of third parties (including separately any such items in favour of any subsidiary or
related party of the customer). Give details of the parties in favour of whom guarantees or
undertakings have been given, whether such guarantees or undertakings are written or oral
and their nature.
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behalf, stating whether there is recourse to your customer and/or to its parent or any other
company within the group.
(f) Other contingent liabilities not already detailed.

Note: for each item state the nature and extent of any facility limits and details of period of availability of agreed
facility.

2 Securities

With reference to the facilities detailed in the above section give the following:

¨ Details of any security formally charged (date, ownership and type of charge). State whether
the security supports facilities granted by the Bank to the customer or to another party.

Note: give details if a security is limited in amount or to a specific borrowing or if to your knowledge there is
prior, equal or subordinate charge.

¨ Where there are any arrangements for set-off of balances or compensating balances eg, back-
to-back loans, give particulars (ie, date, type of document and accounts covered) of any
acknowledgement of set-off, whether given by specific letter of set-off or incorporated in some
other document.

199
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Request for derivatives and commodity trading information

1 Derivatives and commodity trading

Give the currencies, amounts and maturity dates on a contract by contract basis of all outstanding
derivative contracts including the following:

(a) foreign exchange contracts

(b) forward rate agreements
(c) financial futures
(d) interest rate swaps
(e) option contracts
(f) bullion contracts
(g) commodity contracts
(h) swap arrangements (near and far dates)
(i) others (indicate their nature).

Note: indicate the nature and extent of any facility limits, detail period of availability of agreed facilities.

2 Securities

With reference to facilities detailed in the above section give the following:

¨ Details of any security formally charged (date, ownership and type of charge). State whether
the security supports facilities granted by the Bank to the customer or to another party.

Note: give details if a security is limited in amount or to a specific borrowing or if to your knowledge there
is prior, equal or subordinate charge.

¨ Where there are any arrangements for set-off balances of compensating balances eg, back-to-
back loans, give particulars (ie, date, type of document and accounts covered) of any
acknowledgement of set-off, whether given by specific letter of set off or incorporated in
some other document.

Request for custodian arrangements information

1 Custodian arrangements

Give details of the nature and quantity of any assets held but not charged.

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 Chapter 13 The audit of other assets and liabilities

Specimen authority to disclose information

«««««««««%DQNSOF
(Bank address)

«««««««««««««««««/WG

«««««««««««««««««/WG

«««««««««««««««««/WG

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VXEVLGLDULHV WR SURYLGH WR RXU DXGLWRU > ««««««««««««@ DQ\ LQIRUPDWLRQ WKDW WKH\ PD\
request from you regarding all and any of our accounts and dealings with you.

________________________________________
signature(s)

*Delete as appropriate

Specimen request for other information

1 Freehold property

Your customer informs us that you hold the freehold dHHGV WR ««««««««« VSHFLI\
property). Would you please confirm:

(a) that you do hold the deeds;

(b) WKDWWKH\DUHLQWKHQDPHRI«««««««««««««/LPLWHGDQG
(c) that they are/are not* the subject of a legal charge.

*Delete as appropriate

3 The audit of liabilities, capital and reserves

3.1 Introduction
The verification of the financial statements requires the auditor to be satisfied that:

¨ all liabilities are quantified and included in the financial statements.

¨ all liabilities are properly disclosed.
¨ all contingencies and comm itments are identified and disclosed.

In the audit of business transactions, the verification of trade payables and accruals will be
discussed. In this chapter we w ill concentrate on such matters as:

¨ loans and borrow ing.

¨ taxation liabilities.
¨ longer-term liabilities and com mitments.

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Internal controls over liabilities should include segregation of duties and sound accounting
procedures.

W ith regard to segregation of duties, there should be a separation of functions between:

¨ those who authorise the assumption of a liability or obligation.

¨ those who record the liabilities.
¨ those who are instrumental in discharging the liability.

Sound accounting procedures should exist for recording and noting liabilities and ensuring that
they are not omitted from the records.

3.2 Trade payables

An important aspect of the verification of accounts payable is the need to rely on external
evidence, namely:

¨ the use of circularisation procedures for the verification of payable balances.

¨ WKHXVHRIVXSSOLHUV·VWDWHPHQWVIRUYDOLGDWLRQRIEDODQFHVDQGFXWRIIDUUDQJHPHQWV

The verification of trade payables also gives reassurance on the verification of expenditure in
the income statement.

3.3 Circularisation of accounts payable

Considerable audit reassurance can be provided by the use of creditor circularisations. In the
larger audit this type of exercise may be carried out at some period during the year under
review, the presumption being that if internal controls are strong there is no reason w hy
reassurance of this type cannot be gained during an interim visit. This relieves the pressure on
the auditor at the final audit. For small companies where there is no reliance on internal
control, the circularisation exercise is generally performed on the year-end balances.

A comm on form of circular that is sent to clients is set out below.

To ...........

Audit confirmation
Will you please return the attached slip to our auditors, Messrs Pears, Cross, Brannigan & Company
of 131/133 Dutchman Avenue, W21 6EW stating whether or not you agree the enclosed account by
deleting the line which does not apply. In the event of disagreement please give details. A stamped
addressed envelope is enclosed for your reply.
«««««««««««
To: Messrs Pears, Cross, Brannigan & Company, 131/133 Dutchman Avenue, London, W21 6EW
Audit confirmation of balance due from:
Jones Manufacturing plc at 31 March 20X4
Please delete as necessary:
:HFRQILUPWKDWWKHEDODQFHGXHWRXVIURPWKHDERYHFRPSDQ\DWWKHDERYHGDWHZDV««
$FFRUGLQJWRRXUUHFRUGVWKHDPRXQWGXHWRXVE\WKHDERYHFRPSDQ\ZDV««
Yours faithfully

This form of circular seeks a positive result. Other types of circular only require a reply in the
event of disagreement. How ever, there is always the danger that inertia by the correspondent
will be taken to mean agreement.

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 Chapter 13 The audit of other assets and liabilities

3.4 Organising the circularisation exercise

W hilst it is the client that technically sends the circular to the supplier, authorising him to give
the information to the auditor, it is important to ensure that the auditor has control of the
circularisation exercise. He m ust select the sample, complete the circularisation forms, and
control their despatch.

W hen the replies are received they must be examined and compared with the balances in the
books. Differences will arise as follows.

¨ Cash in transit.
¨ Goods in transit.
¨ Unilateral adjustments eg, discounts claimed by one party and disallowed by the other.

Significant differences must be followed up w ith the client as they may indicate attempts to
suppress liabilities, or they may reveal deficiencies in the system of controls. It w ill be
necessary to send further circularisation letters to those persons w ho do not reply until the
auditor is satisfied that a reasonable number of respondents have been circularised in order to
obtain a representative sample.

3.5 Selecting a sample for circularisation

The following might constitute the basis for selecting a sample of accounts payable for
circularisation purposes.

¨ Significant suppliers with credit balances.

¨ Suppliers with debit balances.
¨ 6LJQLILFDQWVXSSOLHUVZLWK´QLOµEDODQFHV
¨ A variety of large, small and medium balances selected from the ledger.
¨ Any accounts known to be in dispute.

3.6 Other substantive tests on trade payables

To verify accounts payable, the following tests may be appropriate.

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composition of the balance and w hether it has been settled after the ledger date.

¨ Checking casts of the payables schedule.

¨ Agreeing the payables schedule to the control account.

¨ Tracing accruals to the nominal ledger from the accruals schedule.

¨ Review ing debit balances to establish cause. Are they due to late invoices? (In w hich case
are they covered by accruals?) Are they prepayments?

¨ ´*URVVLQJXSµSD\DEOHVEDODQFHVE\HOLPLQDWLQJGHELWEDODQFHV

¨ 3HUIRUPLQJ D VXSSOLHUV· VWDWHPHQW UHFRQFLOLDWLRQ 7KLV LV D JRRG DOWHUQDWLYH WR D FUHGLWRUV·
circularisation as it involves third party verification but to existing documents ie, the
VXSSOLHUV·VWDWHPHQWV

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described earlier.

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3.7 Analytical review

An important part of logical evidence is ensuring that the payables figure and the relationship
with other related items in the financial statements do not show any unexpected deviation
from previous years. The following matters will be reviewed.

¨ Key ratios (gross profit/sales, current assets/current liabilities, quick assets/current

liabilities, inventory turnover, purchases/cost of sales).

¨ Comparatives for the above from previous years.

¨ Budgetary estimates for purchases, inventories, payables, cash balances.

¨ Results for the above in the subsequent period.

¨ ,QWHULP PDQDJHPHQW DFFRXQWV ² GR WKH\ UHYHDO VLPLODU WUHQGV DV HYLGHQFHG E\ NH\ UDWLRV
on the accounts under review?

4 Secured loans
4.1 Introduction
The auditor m ust examine loan agreements noting the following points.

¨ The term of the loan.

¨ The rate of interest (fixed or variable).
¨ The security given.
¨ Repayment term s.

W here the loan is issued as a loan note there is likely to be a trust deed which provides, inter
alia, for the following matters.

¨ The terms and dates of redemption of the loan.

¨ The security, if any.

¨ 7KHUHVWULFWLRQVRQWKHFRPSDQ\·VERUURZLQJSRZHUVLP SRVHGE\WKHWUXVWGHHG

¨ Compliance with certain conditions, such as prohibitions on other borrowing, maintaining

certain key ratios (eg, quick asset ratio), and providing m anagement information and/or
LQGHSHQGHQWDFFRXQWDQW·VUHSRUWVWRWKHWUXVWHHV

4.2 Audit work on the balances of loans outstanding

The auditor should obtain schedules of the loan(s), reconciling opening balances, movements
in the year and closing balances.

The redemptions during the year should be vouched by reference to:

¨ DXWKRULW\IRUUHGHPSWLRQ²VXFKDVDGLUHFWRUV·P LQXWH
¨ paid cheques and cash book entries to give effect to the redemption.
¨ the calculation of any discount or premium on redemption.
¨ accrued interest paid on redemption.
¨ the deletions in the register of holders of loans.

The auditor should vouch any fresh loans issued by reference to:

¨ the trust deed, if relevant.

¨ the receipt of m onies in the cash book and nominal ledger.
¨ the entries in the register.

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 Chapter 13 The audit of other assets and liabilities

The auditor w ill test the reconciliation of opening and closing balances, and agree balance
sheet figures and comparatives.

The auditor should scrutinise the statutory books and satisfy himself that they are correct in
respect of:

¨ charges on assets.
¨ GLUHFWRUV·LQWHUHVWVLQORDQV

The interest charge and interest accrual calculations must be checked.

The disclosure of loans in the accounts should give details as follow s.

¨ The relevant amounts are disclosed under liabilities falling due within or after one year as
appropriate.

¨ Convertible loans are shown separately from non-convertible loans.

The details of security for the loans must be disclosed.

5 Taxation
5.1 Objectives
It is important to ensure that the following audit objectives are satisfied:

(a) the liability for taxation is fairly stated by being properly classified and presented;

(b) the provision for the deferred tax liability is adequate and is computed on an
acceptable and consistent basis;

(c) all contingent liabilities are adequately described by way of note.

5.2 Validation of income tax expense

The following steps should be taken:

(a) Review of tax information questionnaire (this is a standard requirement in audit firms
in order to collect, from the client, background and current information w hich will
affect the tax charge).

(b) 5HYLHZFXUUHQW\HDU·VZ RUNLQJSDSHUVQRWLQJWKHDQDO\VLVRILQFRPHDQGH[SHQGLWXUH

and the extraction of expenditure not allowable as deductions against income for tax
purposes.

(c) Examine the draft com putation w ith the available data and compare with the
computation and correspondence for previous years.

(d) Check the calculation of the tax liability on the basis of (c).

(e) Review the charge to the income statement in respect of tax to ensure that it is fairly
computed in the context of (a) and (b) above, and note any transfers to or from the
deferred tax account.

(f) Payments to the tax authorities in respect of tax liabilities should be vouched by
reference to tax correspondence, assessment notices and paid cheques.

6 Dividends
6.1 Introduction
The auditor m ust ensure that suitable routines exist for the audit of dividends, and must attend
to the following.

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6.2 Authority for paying a dividend

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dividends can be proposed by directors but the authority can usually only be verified by the
members in General M eeting.

6.3 Legality of dividend

The provisions of local statute need to be considered when review ing the dividend. These
provisions obviously vary from country to country, but typical rules are as follow s:

(a) A dividend can only be paid out of realised profits.

Realised profits have been received either in cash or cash equivalents, or near-cash assets
such as accounts receivable.

(b) Public companies often have to ensure that a surplus of realised profits exists over
realised and net unrealised losses, both before and after the dividend payment.

(c) A company may not distribute:

(i) share capital;

(ii) share premium account;

(iii) capital redemption reserves;

(iv) a revaluation reserve;

(v) DQ\ RWKHU UHVHUYH ZKRVH GLVWULEXWLRQ LV SURKLELWHG E\ WKH FRPSDQ\·V
constitution.

(d) The legality of a dividend distribution is determined by reviewing the relevant

accounts, which generally means the last audited accounts, which are free of any
significant audit qualification. W here such a qualification exists the auditor is required
to state in his report w hether or not the legality of the distribution is affected thereby.

6.4 Audit validation of dividends

(a) 5HDG WKH GLUHFWRUV· PLQXWH DXWKRULVLQJ WKH LQWHULP GLYLGHQG RU WKH HQWU\ LQ WKH
PHPEHUV·PLQXWHERRNYDOLGDWLQJWKHILQDOGLYLGHQG

(b) Vouch the journal entries in respect of setting up the liability for the dividend.

(c) Vouch the transfer of the dividend from the main bank account to the dividend bank
account.

(d) Review the dividend bank account reconciliation for earlier periods and vouch the
authority for write back of unclaimed dividends.

(e) As most com panies pay their dividends through a bulk clearance scheme operated by
their registrars, a detailed account of a dividend audit is outside the scope of this
section.

7 Sales tax payable

7.1 Transaction cycles
A considerable amount of evidence for the sales tax liability is obtained from the audit of
purchases and sales.

7.2 Audit validation

The additional tests for validation are as follows:

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 Chapter 13 The audit of other assets and liabilities

(a) Examine a sample of sales tax returns and re-perform calculations thereon.

(b) Scan any large or unusual items and note that the sales tax has been treated correctly.

(c) 5HYLHZ RIILFLDO KDQGERRNV LQ UHODWLRQ WR WKH FRPSDQ\·V WUDGH DQG YHULI\ WKDW WKH
system accounts for input tax and output tax properly.

(d) Review payments to and correspondence w ith the tax authorities to ensure that the
liability is being properly discharged.

(e) Vouch payments from the tax authorities where input tax exceeds output tax with
returns and supporting evidence.

(f) Review sales figures with output tax calculations and assess the reasonableness of the
balance.

8 Share capital and reserves

8.1 Capital
The auditor m ust be satisfied that the am ount of share capital is properly stated. Validation
tests that can be applied are:

(a) confirm opening balance with w orking papers and balance sheet;

(b) YRXFKDQ\LVVXHVGXULQJWKH\HDUZLWKGLUHFWRUV·PLQXWHERRNDQGP RQLHVUHFHLYHG

(c) verify postings to share premium account;

(d) confirm year-end balance with share register or (where register is kept by a separate
UHJLVWUDU ZLWKUHJLVWUDU·VGHSDUWPHQW

8.2 Reserves
Audit validation routines on reserves would be as follow s:

(a) The auditor should obtain a schedule of reserves showing opening balances, closing
balances and movements.

(b) The reasons for movements should be validated with:

(i) statutory books²GLUHFWRUV·DQGPHPEHUV·PLQXWHERRNVVKDUHUHJLVWHUHWF

(ii) resolutions to redeem, purchase, issue or forfeit shares.

(c) W here a revaluation reserve is created, the auditor should satisfy himself that there is
an objective basis of valuation and that all the individual movements (by asset class)
are properly identified and disclosed.

9 A useful article
The article below was first published in the ACCA 6WXGHQWV·1 HZVOHWWHUin September 1999 and
is reproduced here by kind perm ission of the ACCA, amended w here necessary to reflect the
International Stream for this paper.

9.1 The balance sheet audit of cash

The objective of this article is to apply the requirements of ISA 400 Risk Assessm ents and Internal
Control and ISA 500 Audit Evidence to the verification of the balance of cash on hand and at
bank. It will be assumed that the appropriate understanding of the transactions classes of cash
receipts and cash payments has been obtained and control risk assessed and tested. The article
is divided into three main sections.

1 Identifying the audit objectives applicable to cash balances.

2 Discussing considerations relevant to developing the audit plan for cash.

207
$&&$3DSHU)7H[W²$XGLWDQG$VVXDUDQFH ,QWHUQDWLRQDO

3 Designing and executing an audit program me for cash.

9.2 Cash audit objectives

Cash balances include cash on hand and at bank. Cash on hand includes undeposited receipts
and petty cash. Cash at bank includes cash held in current and savings accounts which is
available on demand. Unlike any other account balance, cash may be either an asset or a
liability. The latter arises where the bank with w hich the entity holds an account allow s the
entity to write cheques in excess of the balance in the account up to an agreed lim it known as
an overdraft.

Using the assertions described in ISA 500 the audit objectives to be achieved in verifying cash
balances are identified in Table 1.

Table 1: Specific audit objectives for cash balances

Assertion Account balance audit objective

Existence Recorded cash balances exist at the balance sheet date.
Completeness Recorded cash balances include the effects of all cash transactions that have
occurred.
Rights and obligations The entity has legal title to all cash balances shown at the balance sheet date.
Valuation Recorded cash balances are realisable at the amounts stated on the balance
sheet.
Presentation and Cash balances are properly identified and classified in the balance sheet.
disclosure Lines of credit, loan guarantees and other restrictions on cash balances are
appropriately disclosed.

9.3 Developing the audit plan

Developing the audit plan involves the following.

¨ Assessing control risk.

¨ Assessing materiality and inherent risk.
¨ Determining the audit strategy.

Control risk

Although we have assumed that control risks over cash transactions have already been
assessed, there are some control procedures that apply directly to the balance. Of those listed in
ISA 400 paragraph 8, the following fall into this category.

¨ Reconciliations.
¨ Comparing the results of cash, security and inventory counts with accounting records.
¨ Comparing internal data with external sources of information.

A preliminary procedure to planning the audit is to consider the effectiveness of such controls
designed to ensure the correctness of the recorded balance.

Bank reconciliations

The bank statement is a bank prepared listing of its transactions with the customers, normally
issued m onthly. M ost entities verify their balance of cash at bank by reconciling entries in the
cash book with the bank statement. For payments, the procedure is to trace all cheques and
other payments processed by the bank to the cash book or, for cheques issued prior to the
beginning of the month, to the reconciliation prepared at the end of the previous month. Any
cheques in the opening reconciliation or in the cash book that have not been presented to the
bank for payment are recorded in the reconciliation as outstanding cheques. Other deductions
E\ WKH EDQN IURP WKH HQWLW\·V EDODQFH QHHG WR EH UHYLHZHG 7KHVH LQFOXGH GLUHFW GHELWV EDQN

208
 Chapter 13 The audit of other assets and liabilities

FKDUJHV DQG UHYHUVDOV RI GHSRVLWV ZKHUH WKH FKHTXH GHSRVLWHG LV QRW DFFHSWHG E\ WKH LVVXHU·V
bank, often referred to as an NSF (not sufficient funds) returned cheque. The cash book usually
needs to be adjusted to reflect these item s in arriving at the balance of cash per the cash book.

Similarly, comparison is made of deposits. This is much easier as there is usually only a short
delay between the date of deposit and the date the deposit appears on the bank statement.
Again a list of outstanding deposits is prepared. It should then be possible to draw up a bank
reconciliation proving the cash balance by starting with the balance per the bank statement,
deducting outstanding cheques, adding back outstanding deposits and arriving at the balance
shown in the cash book (or cash at bank account in the general ledger).

The level of substantive procedures performed by the auditors depends on the assessment of
control risk over entity prepared reconciliations. The reconciliations should be prepared by
persons independent of the handling and recording of cash transactions and approved by a
responsible official. If control risk is assessed as low the auditors may test the entity prepared
reconciliation. If risk is high, the auditors may need to prepare their own reconciliation.

Cash counts

Since an important control procedure for cash transactions is that all cash be deposited intact
daily, entities are unlikely to have substantial cash balances on hand. The only cash balances
are likely to be petty cash and change floats which are often im material. Petty cash is usually
maintained on an imprest system established by transferring a specified am ount of cash, such
as $200 or $500 to an imprest petty cash fund. W hen cash is paid out of the fund it is replaced
E\ DQ DXWKRULVHG YRXFKHU 7KLV YRXFKHU FRXOG EH D VXSSOLHU·V LQYRLFH RU D VSHFLDO SHWW\ FDVK
voucher authorised by a responsible official. W hen the cash is getting low, the vouchers will be
used as support for a cheque requisition to replenish the fund. The fund should be maintained
at the imprest level in the custody of one individual and periodically independently counted to
ensure that cash and vouchers total to the imprest level.

M ateriality and risk

For many entities, cash balances represent only a very sm all proportion of assets. However, the
amount of cash flowing through the accounts over a period of time is usually greater than for
any other account in the financial statements. M oreover, cash is vital to the survival of the
business as a going concern. The inability of an entity to pay its debts as they fall due because
of a shortage of cash can render a company insolvent, despite the profitability of its operations.
Cash therefore has a materiality that is greater, relative to its balance, than any other account
balance.

The high volume of transactions contributes to a significant level of inherent risk for cash
balance assertions, particularly existence and completeness. In addition, the nature of cash
balances makes them susceptible to theft, as numerous kinds of fraudulent schemes involving
cash have borne out. In contrast to receivables or inventories, however, the risks pertaining to
the rights and obligations, valuations, and presentation and disclosure assertions for cash are
minimal due to the absence of complexities involving these assertions.

Audit strategy

Because of the large volume of transactions and the small account balance, the audit strategy
invariably is to concentrate on verifying the account balance rather than the transactions.
0 RUHRYHUEHFDXVHRIWKHVLJQLILFDQFHRIFDVKWRDQHQWLW\·VOLTXLGLW\DXGLWRUVWHQGWRSODQWKHLU
procedures to detect much smaller levels of misstatements than for any other accounts.

In verifying cash, the auditors must remember that the closing balance may be an overdraft.
The assertions of existence and completeness are thus equally important, given that the balance
may be either an asset or a liability.

9.4 Designing and executing an audit programm e

209
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In performing the substantive audit of cash balances, auditors first assess detection risk and
then design and perform procedures as necessary to achieve that planned level of detection
risk.

Determining detection risk

%HFDXVH RI WKH VLJQLILFDQFH RI FDVK WR WKH HQWLW\·V OLTXLGLW\ DQG WKH IDFW WKDW WKH EDODQFH LV
relatively small, the acceptable level of detection risk in verifying cash balances is invariably set
as low.

Designing and performing substantive procedures

A list of possible substantive procedures to achieve the specific audit objectives for cash
balances is presented in Table 2. The list is organised in accordance with the general
framework for developing audit programmes for substantive procedures w hich was explained
LQ WKH DUWLFOH RQ ´'HVLJQLQJ DXGLW SURFHGXUHVµ LQ WKH -DQXDU\  LVVXH RI WKH 6WXGHQWV·
Newsletter.

Table 2: Possible substantive procedures for cash balance assertions

Category Substantive procedure Cash balance

audit objective
Initial procedures
1 Perform initial procedures on cash balances and Valuation
records:
(a) WUDFHRSHQLQJEDODQFHVWRSULRU\HDU·VZRUNLQJ
papers
(b) review activity in general ledger accounts for
cash
(c) obtain and verify mathematical accuracy of
entity-prepared summaries.
Analytical procedures
2 Perform analytical procedures.
Test of details of
transactions
3 Perform cash cut-off tests (note these tests may have Existence and
been performed as part of the audit programmes for completeness
receivables and payables).
Test of details of balances
4 Count undeposited cash on hand. Existence,
5 Confirm bank balances. completeness,
6 Verify reconciliations as appropriate. rights and
valuation
7 2EWDLQDQGXVHVXEVHTXHQWSHULRG·VVWDWHPHQWV
Presentation and disclosure
8 Compare report presentation with applicable Presentation
accounting standards. and disclosure

9.5 Initial procedures

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WR WKH FORVLQJ DXGLWHG EDODQFHV LQ WKH SULRU \HDU·V Z RUNLQJ SDSHUV 1H[W WKH FXUUHQW SHULRG·V
activity in the general ledger cash accounts should be reviewed for any significant entries that
are unusual in nature or am ount and that may require investigation.

Schedules prepared by the entity showing summaries of undeposited cash receipts at different
locations and/or sum maries of bank balances are obtained. The mathematical accuracy of such
schedules should be determined and their agreement w ith related cash balances in the general
ledger checked. This test provides evidence about the valuation assertion.

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 Chapter 13 The audit of other assets and liabilities

Analytical procedures

Cash balances do not normally show a stable or predictable relationship w ith other current or
historical financial or operating data. However, cash balances can be compared with am ounts
expected from cashflow forecasts.

Tests of details of transactions

A proper cut-off of cash receipts and cash payments at the end of the year is essential to the
proper statement of cash at the balance sheet date. Two cash cut-off tests are performed.

Cash receipts cut-off test. The cash receipts cut-off test is designed to obtain reasonable assurance
that cash receipts are recorded in the accounting period in which received. If the auditors are
present at the year-end date, they can observe that all collections received prior to the close of
business are included in cash on hand or in deposits in transit, and are credited to accounts
receivable. An alternative to personal observation is to review supporting documentation such
as the daily cash sum mary and validated deposit slip for the last day of the year.

Cash payments cut-off test. The usual method of verifying payments cut-off is by exam ining the
date of presentation of cheques outstanding as at the balance sheet date. This test is normally
SHUIRUPHGDVSDUWRIWKHWHVWRIWKHEDQNUHFRQFLOLDWLRQDQGWKHXVH RIWKHVXEVHTXHQWSHULRG·V
bank statement, and is described below.

Tests of details of balances

Substantive tests for cash balances in this category include the following.

¨ Count cash on hand.

¨ Confirm bank balances.
¨ Verify bank reconciliations.
¨ 2EWDLQDQGXVHWKHVXEVHTXHQWSHULRG·VEDQNVWDWHPHQW

Count cash on hand

This test is often omitted as the am ount of cash on hand is rarely material. If it is performed the
following procedures are appropriate.

¨ Control all cash held by the entity until all funds have been counted.

¨ Insist that the custodian of the cash be present throughout the count.

¨ List each item making up the balance.

¨ Obtain a signed receipt from the custodian on return of the funds.

¨ Ascertain that all undeposited cheques are payable to the order of the entity, either directly
or through endorsement.

¨ Trace each item listed to the subsequent bank deposit.

The control of all funds is designed to prevent transfers by entity personnel of counted funds to
uncounted funds. Having the custodian present and requiring his or her signature on return of
the funds minimises the possibility, in the event of a shortage, of the custodian claim ing that all
cash was intact when released to the auditors for counting. Tracing items to the subsequent
deposit tests the possibility of a teeming and lading fraud.

Confirm bank balances

It is customary for the auditors to confirm cash on deposit and loan balances at the balance
sheet date directly w ith the bank. The procedure to be followed is explained in ISA 505 External
Confirmations. A confirmation request should be sent to all banks with w hich the entity had

211
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dealings at any time during the year. In addition to confirmation of the balance outstanding,
the opportunity is also taken to request the bank to furnish other information such as securities
held in safe-keeping.

The confirming of cash on deposit provides evidence primarily as to the existence of cash at
bank (because there is written acknowledgement that the balance exists), and as to rights and
obligations (because the balances are in the name of the entity). The response from the bank
also provides some evidence for the valuation assertion for cash at bank in that the confirmed
balance is used in arriving at the correct cash balance at the balance sheet date. Furtherm ore, it
contributes to the completeness assertion; however, it cannot be relied on entirely because the
bank confirmation usually contains a disclaimer in favour of the bank. The bank cannot be held
liable if the information supplied is incomplete or inaccurate.

The confirming of overdraft and loan balances provides evidence as to the following.

¨ Existence, because there is written acknowledgement that the loan balance exists.
¨ Rights and obligations, because the loan is a debt of the entity.
¨ Valuation, because the response indicates the am ount of the loan balance.

This test also contributes to the completeness assertion in the same manner as confirm ing
deposit balances.

9.6 Verifying bank reconciliations

W hen the entity prepares bank reconciliations on a regular basis that are expected to be
reliable, the auditors will test reconciliations prepared as at the balance sheet date. The test will
normally include the follow ing stages.

Comparing the closing bank balance with the balance confirmed by the bank.

Verifying the validity of deposits in transit and outstanding cheques by

(a) tracing entries in the bank statement for the last month of the fiscal year to the cash
book or bank reconciliation at the beginning of the m onth, marking them off in the
process.

(b) identifying deposits and cheques recorded in the cash book for the last m onth of the
fiscal year, or in the reconciliation at the beginning of that m onth not marked as
appearing on the bank statement, and tracing them to the closing reconciliation.

(c) clearing the bank reconciliation to ensure that all applicable outstanding deposits and
outstanding cheques are marked as having been traced from the cash book and that
none are fictitious.

Establishing the mathematical accuracy of the reconciliation.

Vouching other reconciling item s such as bank charges to supporting documentation.

Investigating old items such as cheques outstanding for a long period of time and unusual
items.

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W hen the entity does not prepare a bank reconciliation or when control risk over entity
prepared reconciliations is high (such as where it is prepared by the cashier), the auditors may
prepare the bank reconciliation. W hen the auditors suspect possible material m isstatements,
the auditors may obtain the year-end bank statement directly from the bank for use in
preparing the bank reconciliation and not rely on the copy of the bank statement held by the
entity. This procedure will prevent the entity from making alterations to the data to cover any

212
 Chapter 13 The audit of other assets and liabilities

misstatements.

Testing or preparing a bank reconciliation establishes the correct cash at bank balance at the
balance sheet date. Thus, it is a primary source of evidence for the valuation assertion. This test
also provides evidence for the existence, completeness, and rights and obligations assertions.

9.7 Obtaining and using the subsequent peULRG¶VEDQNVWDWHP HQW

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IROORZLQJWKHHQWLW\·VILQDQFLDO\HDUHQG7KHHQWLW\VKRXOGEHUHTXHVWHGWRLQVWUXFWWKHEDQNWR
VHQG D FRS\ RI WKH VXEVHTXHQW SHULRG·V EDQN VWDWHPHQW GLUHFWO\ WR WKH DXGLWRUV ,Q WUDFLQJ
outstanding cheques the auditors may find that a prior period cheque not on the list of
outstanding cheques has cleared the bank and that some of the cheques listed as outstanding
have not cleared the bank. The latter may be due to delays in mailing the cheques by the entity
or in depositing the cheques by the payees. The auditors should investigate any unusual
circumstances.

W hen the total of uncleared cheques is material, it may indicate an irregularity know n as
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VROYHQF\ $VVXPH DW EDODQFH VKHHW GDWH WKDW WKH HQWLW\·V EDODQFHV VKRZ FXUUHQW DVVHWV RI
$800,000 and current liabilities of $400,000. If $100,000 of cheques to short-term creditors have
been prematurely entered, the correct totals are current assets of $900,000 and current liabilities
of $500,000, which results in a 1.8:1 current ratio instead of the reported 2:1.) W indow dressing
is normally perpetrated by w riting cheques on the last day of the financial year but not mailing
them until several weeks later, w hen cleared funds are available at the bank to meet those
cheques. If none of a sequence of cheques is presented for payment on the bank statement for
more than tw o weeks after the balance sheet date, the auditors should make inquiries of the
treasurer. Recipients do not usually delay banking cheques once received and it is normal for
most cheques to clear the bank statement within a week of issue.

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relatively simple matter because the first deposit on that statement should be the deposit in
transit shown on the reconciliation. W hen this is not the case, the auditors should determine
the reasons for the delay from the cashier, and corroborate his or her explanations. Delays in
depositing cash receipts could indicate the practice of the fraud know n as teeming and lading.

7KHDXGLWRUVVKRXOGDOVRVFDQWKHVXEVHTXHQWSHULRG·VVWDWHPHQWIRUXQXVXDOLWHPVEHLQJDOHUW
for such items as unrecorded bank debits and credits, and bank errors and corrections.

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auditors secure a high degree of competent corroborating information about the validity of the
year-end bank reconciliation and the existence, completeness, rights and obligations, and
valuation assertions for cash at bank.

9.8 Presentation and disclosure

Cash should be correctly identified and classified in the balance sheet. For example, cash on
deposit is a current asset. A bank overdraft is normally reported as a current liability.

The auditors determine the appropriateness of the financial statement presentation from a
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foregoing substantive procedures. In addition, the auditors should review the minutes of board
RI GLUHFWRUV· PHHWLQJV DQG LQTXLUH RI PDQDJHPHQW IRU HYLGHQFH RI UHVWULFWLRQV RQ WKH XVH RI
cash balances.

9.9 Conclusion
The verification of cash balances is an important part of a financial statement audit. This is

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because even though the balances as of the balance sheet date may appear im material relative
to other assets, the am ount of cash flowing through the accounts during the audit period can
be very material. In addition, cash is susceptible to misappropriation and is involved in many
fraudulent schemes such as teeming and lading. Thus, several types of substantive procedures
of cash balances are performed on most audits including, am ong others, cash cut-off tests,
counting cash on hand, confirm ing balances and other arrangements with banks, reviewing
bank reconciliations, obtaining and using subsequent period bank statements and determining
WKHDGHTXDF\RIPDQDJHPHQW·VGLVFORVXUHVIRUFDVKEDODQFHV

Practice question 1 (The answer is in the final chapter of this book)

Spondon

You have been asked by the manager in charge of the audit of Spondon plc to consider and
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20X5. The company sells all its products on credit and the draft accounts show annual sales of
$25 million and year-end accounts receivable of $5.3 million. Your tests of control on the sales
system have shown that there is a satisfactory division of duties in the sales system and only
minor errors were found in the tests of control.

Required

(a) &RQVLGHUWKHUHOLDELOLW\RIDGHEWRUV·FLUFXODULVDWLRQLQSURYLGLQJDXGLWHYLGHQFHDQGLQ
verifying the value of year-end accounts receivable. (7 marks)

(b) 'HVFULEH WKH ZRUN \RX ZLOO FDUU\ RXW LQ DXGLWLQJ WKH UHSOLHV WR WKH GHEWRUV·
circularisation w here:

(i) the debtor disagrees the balance and provides a different balance (6 marks)

(ii) the debtor does not reply to the circularisation. In answering this part you
should consider

¨ the techniques you w ould use to verify the existence of the debtor

¨ the investigations you w ould carry out to check the recoverability of the
debt on the sales ledger. (7 marks)

7RWDO²PDUNV
Approach to the question

Part (a)

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description of what the test actually entails is relevant even if only as an introduction.

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Part (b)

(i) Think of tw o or three possible reasons for the differences arising and show how you
would verify each one. Use the mark allocation to help you. Six marks is three points
for two marks each: one mark for identifying a possible reason for the difference and
one mark for talking about how you would test it.
(ii) The tw o requirements should be dealt w ith separately as existence and recoverability
are two entirely different test objectives.

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 Chapter 13 The audit of other assets and liabilities

Practice question 2 (The answer is in the final chapter of this book)

Newpiece

Your firm is the auditor of Newpiece Textiles Limited and you are auditing the financial
statements for the year ended 31 October 20X7. The com pany has annual sales of $2.5 million
and a profit before tax of $150,000.

The company has supplied you with the following bank reconciliation at the year end. You
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GHSRVLWVDSSHDUHGRQ1 RYHP EHU·VEDQNVWDWHPHQW

$ $

Balance per bank statement as at 31 October 20X7 (9,865)

Add: deposits not credited

CB date Cheque no Type Date cleared

31 Oct SL 3 Nov 11,364
24 Oct CS 3 Nov 653
27 Oct CS 4 Nov 235
28 Oct CS 5 Nov 315
29 Oct CS 6 Nov 426
30 Oct CS 7 Nov 714
31 Oct CS 10 Nov 362
______
14,069
Less: uncleared cheques

30 Oct 2163 CP 3 Nov 1,216

31 Oct 2164 PL 18 Nov 10,312
31 Oct 2165 PL 19 Nov 11,264
31 Oct 2166 PL 18 Nov 9,732
31 Oct 2167 PL 20 Nov 15,311
31 Oct 2168 PL 21 Nov 8,671
31 Oct 2169 PL 19 Nov 12,869
31 Oct 2170 PL 21 Nov 9,342
31 Oct 2171 CP 3 Nov 964
______
(79,681)
______
Balance per cash book at 31 October 20X7 (75,477)
______

Notes

CB date is the date the transaction was entered in the cash book.
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other expenses)
All cheques for purchase ledger payments (PL) are written out at the end of the month.

215
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Required

(a) Describe:

(i) the matters which cause you concern from your scrutiny of the bank
reconciliation;

(ii) the investigations you will carry out on the item s in the bank reconciliation
which cause you concern;

(iii) the adjustments you will probably require to be made to the financial
statements if your investigations confirm the problems you have highlighted
in (i) above. (10 marks)

(b) The manager in charge of the audit has asked you to consider the petty cash system
and recommend w hat audit work may be necessary. You have found that petty cash is
recorded in a hand written analysed petty cash book and it is not kept on an imprest
system. From the petty cash book you have recorded the petty cash expenditure for
each month as follows.
$
20X6
November 855
December 6,243
20X7
January 972
February 796
March 893
April 751
May 986
June 695
July 749
August 8,634
September 948
October 849
______
Total 23,371
______

Required

(i) Advise the audit manager as to the desirability of performing further

substantive procedures on petty cash. You should consider materiality and
audit risk in relation to the petty cash system. (4 marks)

(ii) Assum ing the audit manager decides that further audit work is necessary,
describe the detailed substantive tests of transactions and balances you should
carry out on the petty cash system. (6 marks)

7RWDO²PDUNV
Approach to the question

It can be intimidating for students when faced with a numbers question on a predominantly
discursive paper. You must remember that you can probably produce a full answer to this
question with reference to only half a dozen of the numbers. If you identify three or four concerns
and talk about the various investigations that you will perform, you will have answered the
question.

A lot of the numbers are included to try to put you off, so do not let them!

216
 Chapter 13 The audit of other assets and liabilities

Practice question 3 (The answer is in the final chapter of this book)

Toton Engineering Ltd

Your firm has been the auditor of Toton Engineering Ltd for a number of years and you have
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September 20X4.

The company has annual sales of about $1.5 million, and your w ork on the purchases system at
the interim audit has revealed:

(a) all goods are received at a central point and a sequentially numbered goods received
note is issued for all goods received;

(b) all valid purchase invoices received by the company are posted to the purchase ledger;

(c) an open item purchase ledger is maintained on a small m icrocom puter, but the
purchases day book and nom inal ledger are prepared manually; and

(d) your tests on the purchases system at the interim audit have revealed no major errors
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7KH GUDIW DFFRXQWV SUHSDUHG E\ WKH FRPSDQ\·V FKLHI DFFRXQWDQW VKRZ WKH IROORZLQJ YDOXH RI
payables at 30 September 20X4:
$
Trade payables 215,130
Sundry payables and accruals 61,270
_______
276,400
_______

The main items in sundry payables and accruals are:

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paid a week in arrears;

(b) sales tax liability;

(c) SXUFKDVHDFFUXDOV²IRUJRRGVUHFHLYHGEXWQRLQYRLFHSRVWHGWRWKHSXUFKDVHOHGJHU.

Required

(a) List and describe the audit tests you w ould perform to verify the value of trade
payables to be included in the balance sheet at 30 September 20X4. Your answer
should describe in detail any tests w here third party evidence is used.

(b) ListDQGEULHIO\GHVFULEHWKHDXGLWWHVWV\RXZRXOGSHUIRUPWRYHULI\WKHLWHP´VXQGU\
SD\DEOHVDQGDFFUXDOVµ<RXUDQVZHUVKRXOGLQFOXGHGHWDLOVRIWHVWVWRHQVXUHWKH IXOO
inclusion of these item s.
(15 marks)

Practice question 4 (The answer is in the final chapter of this book)

Tollerton

You are the senior in charge of the auditRI7ROOHUWRQ/LPLWHGDQG\RXDUHDXGLWLQJWKHFRPSDQ\·V

trade payables at 30 April 20X6.

$MXQLRUPHP EHURIWKHDXGLWWHDPKDVEHHQFKHFNLQJVXSSOLHUV·VWDWHPHQWVWRWKHEDODQFHVRQ
the purchase ledger. He is unable to reconcile a material balance, relating to Carlton Limited,
and has asked for your assistance, and your suggestions on the audit work which should be
carried out on the differences.

217
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7KHEDODQFHRI&DUOWRQ/LPLWHGRQ7ROOHUWRQ/LPLWHG·VSXUFKDVHOHGJHULVVKRZQEHORZ

Purchase ledger

Supplier: Carlton Limited

Date Type Ref Status Dr Cr Balance

10.2 Invoice 6004 Paid 1 2,130
18.2 Invoice 6042 Paid 1 1,525
23.2 Invoice 6057 Paid 1 2,634
4.3 Invoice 6080 Paid 2 3,572
15.3 Invoice 6107 Paid 2 1,632
26.3 Invoice 6154 Paid 2 924
31.3 Payment Cheque Alloc 1 6,163
Discount Alloc 1 126
14.4 Invoice 6285 2,156
21.4 Invoice 6328 3,824
30.4 Payment Cheque Alloc 2 6,005
Discount Alloc 2 123
30.4 Balance 5,980

&DUOWRQ/LPLWHG·VVXSSOLHU·VVWDWHPHQWVKRZVWKHIROORZLQJ

Customer: Tollerton Limited

Date Type Ref Status Dr Cr Balance

7.2 Invoice 6004 2,130
16.2 Invoice 6042 1,525
22.2 Invoice 6057 2,634
2.3 Invoice 6080 3,752
13.3 Invoice 6107 1,632
22.3 Invoice 6154 924
1.4 Receipt Cheque 6,163
4.4 Invoice 6210 4,735
12.4 Invoice 6285 2,156
18.4 Invoice 6328 3,824
28.4 Invoice 6355 6,298
30.4 Balance 23,447

&DUOWRQ·V WHUPV RI WUDGH ZLWK 7ROOHUWRQ DOORZ D  FDVK GLVFRXQW RQ LQYRLFHV Z KHUH &DUOWRQ
receives a cheque from the customer by the end of the m onth following the date of the invoice
(ie, a 2% discount will be given on M arch invoices paid by 30 April).

2Q 7ROOHUWRQ·V SXUFKDVH OHGJHU XQGHU ´6WDWXVµ WKH FDVK DQG GLVFRXQW PDUNHG ´$OORF µ SD\
LQYRLFHVPDUNHG´3DLGµ VLPLODUO\IRU´$OORFµDQG´3DLGµ 

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UHFHLYHGQRWH *51 $FRS\RIWKH*51DQGWKHVXSSOLHU·VDGYLFHQRWHLVVHQW WR WKHSXUFKDVHV
accounting department.

218
 Chapter 13 The audit of other assets and liabilities

Required

(a) 3UHSDUH D VWDWHPHQW UHFRQFLOLQJ WKH EDODQFH RQ 7ROOHUWRQ·V SXUFKDVH OHGJHU WR WKH
EDODQFHRQ&DUOWRQ·VVXSSOLHU·VVWDWHPHQW (4 marks)

(b) Describe the audit work you will carry out on each of the reconciling item s you have
determined in your answer in part (a) above, in order to determine the balance w hich
should be included in the financial statements. (10 marks)

(c) In relation to verifying trade payables:

(i) FRQVLGHUWKHEDVLV\RX ZLOOXVHIRUVHOHFWLQJVXSSOLHUV·VWDWHPHQWVWRFKHFNWKH

balances on the purchase ledger; and

(ii) GHVFULEHZKDWDFWLRQ \RX ZLOO WDNH LI \RX ILQG WKHUH LV QR VXSSOLHU·V VWDWHPHQW
for a material balance on the purchase ledger. (6 marks)

7RWDO²PDUNV

Approach to the question

In parts (a) and (b) you should not be put off by the fact that there are numbers in the question.

,I\RXUUHFRQFLOLDWLRQGRHVQRWDFWXDOO\UHFRQFLOHWKHQGRQ·WSDQLF

The second part of the question asks you to describe the audit w ork you w ould carry out on
the reconciling items. So make sure you find a number of different ones. Ensure you have:

¨ an item of cash in transit

¨ an invoice in transit
¨ a discount problem.

Also check for transposition errors.

W ith regard to part (c), when auditing assets we are generally testing for overstatement so we
test what we can see; if we cannot prove it then assets may be overstated.

With liabilities we are generally testing for understatement. We test what we see and then ask the
question: is there anything else? But how can we test what is not there?

Third party evidence is vital w hen auditing liabilities and should form the basis for sampling
ZKHUHYHU SRVVLEOH 6R XVH WKH VXSSOLHUV· VWDWHPHQWV LQVWHDG RI WKH LQWHUQDOO\ JHQHUDWHG
purchase ledger listing.

10 Summary
Other than inventories and non-current assets, the main balance sheet areas are receivables,
cash and bank balance and liabilities.

: LWKUHJDUGWRDFFRXQWVUHFHLYDEOHWKHNH\DXGLWVWHSLVDGHEWRUV·FLUFXODULVDWLRQ7KHDXGLWRU
should also look at cash received after the year end.

W ith regard to bank balances, the key audit step is the bank letter. This is sent by the auditor to
WKHFOLHQW·VEDQNDQGFRQWDLQVDVWDQGDUGOLVW RITXHVWLRQVUHFRJQLVHGE\WKHEDQNLQJLQGXVWU\
Another important step is to reconcile bank statements with cash books.

Under the heading of liabilities the most important area is trade payables. Key audit
SURFHGXUHV LQFOXGH UHFRQFLOLDWLRQV EHWZHHQ SXUFKDVH OHGJHU EDODQFHV DQG VXSSOLHUV·
VWDWHPHQWVDQGDFUHGLWRUV·FLUFXODULVDWLRQ

If the auditor discovers material errors in any of the system s dealt with in this chapter, he
should report those errors to management in accordance with ISA 260.

219
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220