AA - Audit and Assurance
Contents
Audit of Specific Balances - Intro and Non-current Assets .................................................... 2
GENERAL PRINCIPLES OF AUDIT PROCEDURES .................................................................. 2
SUBSTANTIVE AUDIT PROCEDURES .................................................................................... 3
NON-CURRENT ASSETS ....................................................................................................... 3
Audit of Specific Balances - Current Assets ............................................................................ 6
BANK ................................................................................................................................... 6
ACCOUNTS RECEIVABLE...................................................................................................... 7
Audit of Specific Balances Liabilities ...................................................................................... 9
ACCRUALS ........................................................................................................................... 9
PROVISIONS ........................................................................................................................ 9
OTHER LIABILITIES ............................................................................................................ 10
TRADE PAYABLES .............................................................................................................. 10
Audit of Specific Balances - P&L, Directors, and Equity ....................................................... 12
THE STATEMENT OF PROFIT AND LOSS ............................................................................ 12
DIRECTORS' EMOLUMENTS .............................................................................................. 13
EQUITY .............................................................................................................................. 14
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Audit of Specific Balances - Intro and Non-current Assets
GENERAL PRINCIPLES OF AUDIT PROCEDURES
Substantive audit procedures are procedures that identify if material misstatements are
present within the financial statements. They test the transactions, balances and disclosures
for these misstatements. The steps to performing a substantive test are:
1. Identify the item to test and set the objectives of the test;
2. Consider the quality of evidence required. It must be sufficient and
appropriate;
3. Design the test and ensure it meets the objective;
4. Select the sample of transactions to perform the test on;
5. Record the test, method, results and other evidence as working papers; and
6. Consider the conclusion of the test.
The objective of a substantive test must be at least one of these financial statement
assertions:
C Completeness C Cut-off
R Rights and obligations O Occurrence
A C Classification and
V Allocation and valuation understandability
E Existence A Accuracy
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SUBSTANTIVE AUDIT PROCEDURES
Procedures that can be performed for any balance can be remembered using the mnemonic
TOAD:
– Trial balance: To agree the balance in the financial statements to the trial balance;
– Opening balance: To agree the opening balance to last year's closing balance and
investigate any differences with the client;
– Add up and recalculate: All balances need to be checked for accuracy; and
– Disclosure check: To review any specific accounting standards relating to the area of the
financial statements and ensure they have been followed when preparing the financial
statements.
NON-CURRENT ASSETS
In order to ensure non-current assets are audited effectively, the auditor will need to
review:
– The financial statements, including the statement of financial position and the non-
current asset note;
– The asset register, which includes all details relating to the assets held by the company;
and
– The trial balance and ledger accounts forming the non-current asset balance.
The key assertions to be verified for non-current assets are:
– Completeness (C);
– Rights and obligations (R&O);
– Valuation (V); and
– Existence (E).
The auditor needs to ensure that each balance has been audited, therefore auditing:
1. Opening and closing balances: Procedures include:
a. Agreeing the opening balance to last year's financial statement;
b. Adding up the non-current asset note to ensure the auditor agrees with the
closing balance shown; and
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c. Agreeing the closing balance for non-current assets in the note, to the
balance shown on the statement of financial position.
2. New assets purchased or additions: Procedures include:
a. Agreeing the additions balance in the financial statements to the asset
register (C);
b. Adding up the additions in the asset register to ensure they agree with the
total in the financial statements (C); and
c. For additions in the year, trace to invoice, to agree amounts recorded and
whether the invoice is in the company name (R&O).
3. Disposals of assets in the year: The auditor should:
a. Obtain a list of all disposals of assets made in the year and agree them to the
asset register to ensure they have now been removed (E and A);
b. Agree disposals to documentation, for example, sales receipts and bank
statements to prove they were disposed of (E and A); and
c. Review the profit or loss on disposal and agree with what has been recorded
in the statement of profit and loss (E and A).
4. Depreciation: Must be audited by:
a. Recalculating the depreciation charge for a sample of assets (V and A);
b. Reviewing the accounting policies to see if the treatment being used is
consistent with prior years’ (V and A); and
c. Inspecting the budgets for capital expenditure to see if plans for disposals
and new assets mean the depreciation methods are appropriate (V and A).
5. Revaluations: Procedures would be:
a. Inspect the valuer's report and agree the amount concluded by them with
what has been recorded in the financial statements (V); and
b. Review the methods used by the valuer described in their report and ensure
they agree with what is required by the accounting standards for revaluations
(V).
Notes:
– The key for an auditor is to gather as much sufficient appropriate evidence as possible.
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– The more written, detailed, independent evidence auditors can collect, the better.
– Each audit procedure must verify at least one of the financial statement assertions.
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Audit of Specific Balances - Current Assets
BANK
The bank is an asset presented in the financial statements. It is shown under the heading
"Current Assets" in the statement of financial position.
The key assertions that should be verified are:
– Valuation (V); and
– Existence (E).
The evidence that the auditor would obtain can be referred to as the three B’s:
1. The bank statement: This will show all movements in the bank balance
during the period that can be agreed with the movements in the cash book (E
and V);
2. The bank report: This is written confirmation from the bank sent directly to
the auditor, which confirms all the bank balances held by the client for the
year end and any balances of liabilities held by them. The auditor should also
agree the bank accounts to the trial balance (E, V and C); and
3. The bank reconciliation: This will show the differences between what the
cash book states as the balance and what the bank states as the balance.
Auditors should also ensure that balances agree to the bank statement, bank
report and cash book.
Unpresented cheques are any payments that have not yet been cleared by the bank. The
auditor would usually:
– Agree the amounts on the bank reconciliation to the cheque stubs and cash book;
– Ensure none of the payments are missing or belong in the following period; and
– Inspect the bank statements after the year end to ensure the payments have now
cleared. Then any uncleared receipts would be audited. Auditors would need to:
– Agree that all uncleared receipts on the bank reconciliation are in the cash book;
– Ensure there are no missing receipts from the cash book; and
– Inspect the bank statements after the year end to ensure the receipts have now
cleared.
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ACCOUNTS RECEIVABLE
Accounts receivable balance is actually made up of two balances in the ledger, the trade
receivables, and any provision for bad debts. There are three important tests auditors
should carry out on this balance:
1. Circularisation: It is writing to a sample of trade receivable customers requesting
that they confirm the balance they owe from their records. If the response does not
agree with the ledger, the auditor will then need to complete a reconciliation
between the client and customer balance to identify if the difference is due to
timings issues, or due to a misstatement;
2. Cash received after the year end: The auditor will select a sample of receivable
customer balances and then agree these balances to receipts in the post year end
bank statements (E);
3. Cut-off: The auditor should review invoices just before and after the year end, and
inspect their goods dispatch notes, reviewing the delivery date to ensure they are in
the correct period.
The next step is then to audit the provision for bad debts. The key assertion to verify is
valuation. Examples of procedures include:
– Comparing the provision to the previous year and investigating any differences;
– Calculating the receivables days ratio and comparing it to the previous year;
– Reviewing the aged receivables list and investigating old balances to see if they should
be included in the provision or written off;
– Enquiry with management about any specific provisions; and
– Post year end event review to see if the customer has paid.
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INVENTORY
Key assertion Procedures
According to IAS 2, inventory should be valued at the lower of cost and
net realisable value.
_ The auditor must review sales around the year end;
Valuation _ Sales prices of items should be compared to the calculations for
net realisable value to ensure the selling price looks reasonable;
and
_ The auditor should trace the cost used in valuation to the source
document such as the purchase invoice.
_ This assertion can be verified by attending the inventory count.
This also enables the auditor to review the control procedures
Existence and
carried out by the client.
completeness
Using samples for counting, the auditor verifies the existence and
completeness of counting records.
_ Inspection of ownership documentation should be carried out; as
well as review of the purchase invoices; and
Rights and obligations
_ Inspection of any inventory stored at third party warehouses and
review of respective agreements.
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Audit of Specific Balances Liabilities
Key concern: The client may have understated the balance to make the business look
healthier and more liquid than it is.
Key assertions: Completeness, rights and obligations, valuation.
ACCRUALS
Accruals balance is based on costs that may not have been invoiced in the year but belong
to the current year. The following procedures should be performed:
– Obtain a breakdown of the accruals balance and ensure it adds up and agrees with the
accruals balance in the financial statements;
– Compare accruals balance to last year and investigate any differences; and
– Review invoices dated after the year end to identify if the costs belong to the current
year;
PROVISIONS
Provisions could arise from events such as potential compensation payments from court
cases. The client needs to ensure they have followed the rules of IAS 37:
– If there is a remote chance of the client suffering an outflow of resources, then there
should be nothing included in the financial statements;
– If there is a possible chance of the client suffering an outflow of resources, then there
should be a disclosure note called a contingent liability note explaining the possible
event, but still, no provision;
– If there is a probable outflow of resources, then a provision may be included in the
financial statements and a disclosure note explaining the balance.
There are three criteria that must be met for a provision to be allowed:
1. There must be a present obligation due to a past event;
2. There must be a probable outflow of resources; and
3. There must be a reliable estimate.
In order to be satisfied that all criteria mentioned above are met, the auditor must perform
the following procedures:
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– They must inspect correspondence, for example, from the company lawyer, and also
discuss the event with them;
– They can inspect any other external evidence, such as press reports, if they relate to a
court case; and
– They must then obtain evidence on the estimate of costs and ensure it is from a reliable
source. This must not be an estimate from the client management.
OTHER LIABILITIES
Other liability balances include:
– Sales tax;
– Employee tax;
– Payroll; and
– Bank overdrafts.
The following procedures may be performed to verify these balances:
– Agree each of these balances to the bank statement as the payment should be shown
after the year end (except for bank overdraft, as there may be timing differences); and
– The bank reconciliation will play a part in verifying the bank overdraft balance, along
with the bank report.
TRADE PAYABLES
Trade payables is the total balance of all outstanding balances owed to trade suppliers.
Audit procedures will include:
1. Cut-off testing: The procedure would be to identify the invoices posted just before
and after the year end,
compare them to the goods received note, review the delivery date, and ensure the invoice
is posted in the correct period;
2. Reconciling supplier statements: The auditor should select a sample of suppliers and
reconcile the supplier statement sent at the year end to the ledger (timing differences
are acceptable);
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3. Post year end invoice review: Inspecting purchase invoices since year end and
reviewing the details will be required to ensure that there were no invoices that
should have been included in the current year;
4. Analytical procedures: These include:
– Comparing the balance to the previous year and investigating any significant
differences;
– Calculating the payable days ratio and comparing to the previous year;
– Identifying the trade payables balance for each month and comparing the level of
payables to the expected trend of the company; and
– Inspecting the aged payable analysis, in particular, identifying the old and slow
moving balances and investigating these with the client.
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Audit of Specific Balances - P&L, Directors, and Equity
THE STATEMENT OF PROFIT AND LOSS
Remember: Much of the transactions in the P&L have already been tested via the
corresponding debit or credit balance in the SFP.
The key assertions for the statement of profit and loss balances are:
– Cut-off (C/O);
– Occurrence (O);
– Completeness (CO);
– Classification (C); and
– Accuracy (A).
For the payroll balance, a few specific audit procedures include:
– For a sample of employee balances, recalculate the deductions, such as tax, and
investigate any differences;
– Agree the net pay as per the payroll records to the bank statements and cash book; and
– Agree total wages and salaries from the payroll system to the trial balance and financial
statements.
Analytical procedures:
– Proof in total of the wages and salaries balance (estimate the balance from
management information such as average wages and the percentage pay rise) and
compare it to the actual balance.
– Comparing the current year's balance to the previous year's will also identify
potential misstatements if significantly different.
The revenue balance substantive tests include:
– For a sample of invoices, to recalculate the sales tax and discounts for accuracy;
– Agree a sample of customer orders to the dispatch notes and invoices to ensure they
were recorded; and
– Inspecting credit notes issued shortly after the year end and supporting documentation
for evidence that they were related to actual sales and not created to overstate
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revenue.
– Analytical procedures:
– Comparing the revenue balance to the previous year;
– Calculating and comparing gross profit margins to previous years; and
– Comparing the balance to budgeted figures.
The purchase and other expense balance procedures include:
– Inspecting purchase orders and agreeing these to the goods received notes and invoices
recorded;
– Recalculating sales tax and discounts on a sample of invoices; and
– Agreeing the balance on the ledger to the trial balance and financial statements.
Analytical procedures:
– Calculate operating profit margin to compare to the previous year, investigating any
significant differences; and
– Comparing each expense account to budget to identify anything to investigate further.
DIRECTORS' EMOLUMENTS
Remember: the auditor regards any director's transactions as material by nature. The key
assertion is accuracy. An example of audit procedures would be:
– Obtain the detailed list of directors' transactions which shows the split between wages,
bonuses, pensions etc., and check it to ensure all the totals are correct;
– Inspect payroll records and agree the balances to the list;
– Inspect bank statements and agree amounts actually paid; and
– Obtain a written representation from the directors that they have included all directors'
remuneration to the auditor.
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EQUITY
The financial statements will include the statement of changes in equity (SOCIE) which will
show the movement in equity section from the beginning of the year. The equity section will
include the following balances:
1. Share capital: To verify this balance, the auditor will need to:
a. Inspect share certificates or other official documentation and agree to
disclosures made in the financial statements;
b. Inspect board minutes for evidence of a share issue; and
c. Inspect the cash book for evidence of money coming in from a share issue.
2. Dividends: This will require the auditor to:
a. Inspect board minutes to ensure the amount and that the date declared was
before the year end; and
b. Inspect the bank statement to agree the amounts paid and that they were
before the year end also.
3. Other reserves: To audit this balance, the auditor must ensure:
a. The opening balance agrees to last year;
b. The movements in reserves add up to the closing balance; and
c. Any movements agree with supporting documentation, for example, a
valuation report.
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