PAS 2 INVENTORIES

IAS 2 Inventories contains the requirements on how to account for most types of inventory. The
standard requires inventories to be measured at the lower of cost and net realisable value (NRV)
and outlines acceptable methods of determining cost, including specific identification (in some
cases), first-in first-out (FIFO) and weighted average cost.
A revised version of IAS 2 was issued in December 2003 and applies to annual periods
beginning on or after 1 January 2005.

Disclosure
Required disclosures: [IAS 2.36]
 accounting policy for inventories
 carrying amount, generally classified as merchandise, supplies, materials, work in
progress, and finished goods. The classifications depend on what is appropriate for the entity
 carrying amount of any inventories carried at fair value less costs to sell
 amount of any write-down of inventories recognised as an expense in the period
 amount of any reversal of a write-down to NRV and the circumstances that led to such
reversal
 carrying amount of inventories pledged as security for liabilities
 cost of inventories recognised as expense (cost of goods sold).

HOW TO AUDIT CASH

IAS 2 acknowledges that some enterprises classify income statement expenses by nature
(materials, labour, and so on) rather than by function (cost of goods sold, selling expense, and so
on). Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an
entiSubstantive Procedures for Cash
1. Confirm cash balances.
2. Vouch reconciling items to the subsequent month's bank statement.
3. Ask if all bank accounts are included on the general ledger.
4. Inspect final deposits and disbursements for proper cutoff.

How to Audit Cash

In this post, we will take a look at the following:

 Primary cash assertions

 Cash walkthrough

 Directional risk for cash

 Primary risks for cash

 Common cash control deficiencies

 Risk of material misstatement for cash

 Substantive procedures for cash

 Common cash work papers

Primary Cash Assertions

The primary relevant cash assertions are:

 Existence

 Completeness

 Rights

 Accuracy

 Cutoff

Of these assertions, I believe existence, accuracy, and cutoff are most important. The audit client
is asserting that the cash balance exists, that it’s accurate, and that only transactions within the
period are included.
Classification is normally not a relevant assertion. Cash is almost always a current asset. But
when bank overdrafts occur, classification can be in play. The negative cash balance can be
presented as cash or as a payable depending on the circumstances. 
Cash Walkthrough
As we perform walkthroughs of cash, we normally look for ways that cash might be overstated
(though it can also be understated as well). We are asking, “What can go wrong?” whether
intentionally or by mistake.
In performing cash walkthroughs, ask questions such as:

 Are timely bank reconciliations performed by competent personnel?

 Are all bank accounts reconciled?

 Are the bank reconciliations reviewed by a second person?

 Are all bank accounts on the general ledger?

 Are transactions appropriately cut off at period-end (with no subsequent period

transactions appearing in the current year)?

 Is there appropriate segregation between persons handling cash, recording cash, making
payments, and  reconciling the bank statements

 What bank accounts were opened in the period?

 What bank accounts were closed in the period?

 Are there any restrictions on the bank accounts?

 What persons are on the bank signature cards?

 Who has the authority to open and/or close bank accounts?

 What is the nature of each bank account (e.g., payroll bank account)?
 Are there any cash equivalents (e.g., investments of less than three months)

 Were there any held checks (checks written but unreleased) at period-end?

As we ask questions, we also inspect documents (e.g., bank reconciliations) and make
observations (who is doing what?).

If controls weaknesses exist, we create audit procedures to address them. For example, if during
the walkthrough we review three monthly bank reconciliations and they all have obvious errors,
we will perform more substantive work to prove the year-end bank reconciliation. For example,
we might vouch every outstanding deposit and disbursement.
Directional Risk for Cash
What is directional risk? It’s the potential bias that a client has regarding an account balance. A
client might desire an overstatement of assets and an understatement of liabilities  since each
makes the balance sheet appear healthier.

The directional risk for cash is overstatement. So, in performing your audit procedures, perform
procedures such as testing the bank reconciliation to ensure that cash is not overstated.

Primary Risks for Cash

The primary risks are:

1. Cash is stolen
2. Cash is intentionally overstated to cover up theft
3. Not all cash accounts are on the general ledger
4. Cash is misstated due to errors in the bank reconciliation
5. Cash is misstated due to improper cutoff
Common Cash Control Deficiencies
In smaller entities, it is common to have the following control deficiencies:
 One person receipts and/or disburses monies, records those transactions in the general
ledger, and reconciles the related bank accounts

 The person performing the bank reconciliation does not possess the skill to perform the
duty

 Bank reconciliations are not timely performed

Risk of Material Misstatement for Cash

In my smaller audit engagements, I usually assess control risk at high for each assertion. If
control risk is assessed at less than high, then controls must be tested to support the lower risk
assessment. Assessing risks at high is usually more efficient than testing controls.
When control risk is assessed at high, inherent risk becomes the driver of the risk of material
misstatement (control risk X inherent risk = risk of material misstatement). For example, if
control risk is high and inherent risk is moderate, then my RMM is moderate. 

The assertions that concern me the most are existence, accuracy, and cutoff. So my RMM for
these assertions is usually moderate to high. 

My response to higher risk assessments is to perform certain substantive procedures: namely,

bank confirmations and testing of the bank reconciliations. As RMM increases I examine more
of the period-end bank reconciliations and more of the outstanding reconciling items. Also, I am
more inclined confirm the balances.

Substantive Procedures for Cash

My customary audit tests are as follows:

1. Confirm cash balances

2. Vouch reconciling items to the subsequent month’s bank statement

3. Ask if all bank accounts are included on the general ledger

4. Inspect final deposits and disbursements for proper cutoff

The auditor should send confirmations directly to the bank. Some individuals create false bank
statements to cover up theft. Those same persons provide false confirmation addresses. Then the
confirmation is sent to an individual (the fraudster) rather than a bank. Once received, the
fraudster replies to the confirmation as though the bank is doing so. You can lessen the chance of
fraudulent confirmations by using Confirmation.com, a company that specializes in bank
confirmations. Alternatively, you might Google the confirmation address to verify its existence.

Agree the confirmed bank balance to the period-end bank reconciliation (e.g., December 31,
20X7). Then, agree the reconciling items on the bank reconciliation to the bank statement
subsequent to the period-end. For example, examine the January 20X8 bank statement activity
when clearing the December 20X7 reconciling items. Finally, agree the reconciled balance to the
general ledger cash balance for the period-end (e.g., December 31, 20X7).

Cut-off bank statements (e.g., January 20, 20X8 bank statement) may be used to test the
outstanding items. Such statements, similar to bank confirmations, are mailed directly to the
auditor. Alternatively, the auditor might examine the reconciling items by viewing online bank
statements. (Read-only rights can be given to the auditor.)

Common Cash Work Papers

My cash work papers normally include the following:

 An understanding of cash-related internal controls 

 Risk assessment of cash assertions at the assertion level

 Documentation of any control deficiencies

  Cash audit program

 Bank reconciliations for each significant account

 Bank confirmations

In Summary
We’ve discussed how to perform cash risk assessment procedures, the relevant cash assertions,
the cash risk assessments, and substantive cash procedures. 

Inventory audit procedures

August 04, 2019

If your company records its inventory as an asset and it undergoes an

annual audit, then the auditors will be conducting an audit of your
inventory. Given the massive size of some inventories, they may engage
in quite a large number of inventory audit procedures before they are
comfortable that the valuation you have stated for the inventory asset is
reasonable. Here are some of the inventory audit procedures that they
may follow:

 Cutoff analysis. The auditors will examine your procedures for

halting any further receiving into the warehouse or shipments from it at
the time of the physical inventory count, so that extraneous inventory
items are excluded. They typically test the last few receiving and shipping
transactions prior to the physical count, as well as transactions
immediately following it, to see if you are properly accounting for them.

 Observe the physical inventory count. The auditors want to be

comfortable with the procedures you use to count the inventory. This
means that they will discuss the counting procedure with you, observe
counts as they are being done, test count some of the inventory
themselves and trace their counts to the amounts recorded by the
company's counters, and verify that all inventory count tags were
accounted for. If you have multiple inventory storage locations, they may
 test the inventory in those locations where there are significant amounts
of inventory. They may also ask for confirmations of inventory from the
custodian of any public warehouse where the company is storing
inventory.

 Reconcile the inventory count to the general ledger. They will trace
the valuation compiled from the physical inventory count to the
company's general ledger, to verify that the counted balance was carried
forward into the company's accounting records.

 Test high-value items. If there are items in the inventory that are of
unusually high value, the auditors will likely spend extra time counting
them in inventory, ensuring that they are valued correctly, and tracing
them into the valuation report that carries forward into the inventory
balance in the general ledger.

 Test error-prone items. If the auditors have noticed an error trend in

prior years for specific inventory items, they will be more likely to test
these items again.

 Test inventory in transit. There is a risk that you have inventory in

transit from one storage location to another at the time of the physical
count. Auditors test for this by reviewing your transfer documentation.

 Test item costs. The auditors need to know where purchased costs
in your accounting records come from, so they will compare the amounts
in recent supplier invoices to the costs listed in your inventory valuation.

 Review freight costs. You can either include freight costs in

inventory or charge it to expense in the period incurred, but you need to
be consistent in your treatment - so the auditors will trace a selection of
freight invoices through your accounting system to see how they are
handled.

 Test for lower of cost or market. The auditors must follow the lower
of cost or market rule, and will do so by comparing a selection of market
prices to their recorded costs.
 Finished goods cost analysis. If a significant proportion of the
inventory valuation is comprised of finished goods, then the auditors will
want to review the bill of materials for a selection of finished goods items,
and test them to see if they show an accurate compilation of the
components in the finished goods items, as well as correct costs.

 Direct labor analysis. If direct labor is included in the cost of

inventory, then the auditors will want to trace the labor charged during
production on time cards or labor routings to the cost of the inventory.
They will also investigate whether the labor costs listed in the valuation
are supported by payroll records.

 Overhead analysis. If you apply overhead costs to the inventory

valuation, then the auditors will verify that you are consistently using the
same general ledger accounts as the source for your overhead costs,
whether overhead includes any abnormal costs (which should be charged
to expense as incurred), and test the validity and consistency of the
method used to apply overhead costs to inventory.

 Work-in-process testing. If you have a significant amount of work-in-

process (WIP) inventory, the auditors will test how you determine the
percentage of completion for WIP items.

 Inventory allowances. The auditors will determine whether the

amounts you have recorded as allowances for obsolete inventory or scrap
are adequate, based on your procedures for doing so, historical patterns,
"where used" reports, and reports of inventory usage (as well as by
physical observation during the physical count). If you do not have such
allowances, they may require you to create them.

 Inventory ownership. The auditors will review purchase records to

ensure that the inventory in your warehouse is actually owned by the
company (as opposed to customer-owned inventory or inventory on
consignment from suppliers).
 Inventory layers. If you are using a FIFO or LIFO inventory valuation
system, the auditors will test the inventory layers that you have recorded
to verify that they are valid.

If the company uses cycle counts instead of a physical count, the auditors
can still use the procedures related to a physical count. They simply do so
during one or more cycle counts, and can do so at any time; there is no
need to only observe a cycle count that occurs at the end of the reporting
period. Their tests may also evaluate the frequency of cycle counts, as
well as the quality of the investigations conducted by counters into any
variances found.

The extent of the procedures employed will decline if inventory

constitutes a relatively small proportion of the assets listed on a
company's balance sheet.

Audit Readiness (4) – Property, Plant and Equipment

External Auditors of most manufacturing organisations usually scope in PPE
as a risk area during their annual audit due to its materiality. A combination
of controls testing and substantive testing is usually adopted when obtaining
audit assurance on PPE.
The subject matter for discussion on audit readiness this week is Property,
Plant and Equipment (PPE). This item falls within the scope of IAS 16. This
standard is applicable in accounting for property, plant and equipment,
which it defines as tangible items that:

 Are held for use in the production or supply of goods or services, for
rental to others, or for administrative purposes

 Are expected to be used during more than one period.

The Standard excludes the following from its scope:

Property, plant and equipment classified as held for sale in accordance with
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations;

 Biological assets related to agricultural activity (IAS 41 Agriculture);

and

 Mineral rights and mineral reserves such as oil, natural gas and similar
non-regenerative resources.
External Auditors of most manufacturing organisations usually scope in PPE
as a risk area during their annual audit due to its materiality. A combination
of controls testing and substantive testing is usually adopted when obtaining
audit assurance on PPE.

Within the business cycles selected for testing during a particular period, the
principal business activities and the sub processes are tested. The objectives
for testing the sub processes are:

Acquiring fixed assets

Recorded fixed asset acquisitions represent fixed assets acquired by the

organization.

Fixed asset acquisitions are accurately recorded.

Fixed asset acquisitions are recorded in the appropriate period.

All fixed asset acquisitions are recorded.

The recognition criteria for property, plant and equipment are derived from
the general principles for asset recognition reflected in the Conceptual
Framework for Financial Reporting. An item of property, plant and equipment
is to be recognised as an asset if, and only if:

 It is probable that future economic benefits associated with the asset

will flow to the entity; and

 The cost of the asset to the entity can be measured reliably.

Depreciating fixed assets       

Depreciation charges are valid.

Depreciation charges are accurately calculated and recorded.

All depreciation charges are recorded in the appropriate period.

Depreciation, as defined in IAS 16:6, is the systematic allocation of the

depreciable amount of an asset (i.e. the cost of the asset, or other amount
substituted for cost, less its residual value) over its useful life. In order to
comply with the requirements of IAS 16 relating to depreciation, it is
necessary to identify:

The parts (components) of each item of property, plant and equipment that
are to be depreciated separately;

 The cost or valuation of each separately depreciable component;

  The estimated residual value of each separately depreciable
component;

 The length of time during which each separately depreciable

component will be commercially useful to the entity; and

 The most appropriate depreciation method for each separately

depreciable component.

Disposing of fixed assets

Recorded fixed asset disposals represent actual disposals.

All fixed asset disposals are recorded.  

Fixed asset disposals are accurately calculated and recorded.

Fixed asset disposals are recorded in the appropriate

period.                                  

Managing fixed assets

Records of fixed asset maintenance activity are accurately

maintained.                          

Fixed assets are adequately safeguarded.

Fixed asset maintenance records are updated timely.

Fixed assets reflect the existing business circumstances and economic

conditions in accordance with the accounting policies being used.

Financial information is not presented in a misleading way and all

information that is necessary for fair presentation and compliance with
professional standards or legal requirements is disclosed.

Maintaining fixed asset register and/or master file

Only valid changes are made to the fixed asset register and/or master file.

All valid changes to the fixed asset register and/or master file are input and
processed.

Changes to the fixed asset register and/or master file are accurate.

Changes to the fixed asset register and/or master file are processed timely.

Fixed asset register and/or master file data remains pertinent.

External Auditors would always request to examine documents to support
the assertions that the above objectives are reasonably met. Processes that
do not leave a visible trail are tested via observation or re-performance.

Where internal controls are strong, Auditors may reduce the planned level of
substantive assurance. This is usually the case and that is why it is desirable
for entities to ensure that internal controls are very in design and also very
efficient and effective in operation. 

 Impairment Review

External Auditors may also be interested in entities impairment review

documentation. Entities should refer to the requirements of IAS 36
Impairment of Assets to determine whether an item of property, plant and
equipment is impaired. IAS 36 explains how an entity reviews the carrying
amount of its assets, how it determines the recoverable amount of an asset,
and when it recognises or reverses an impairment loss.

Occasionally, an entity may receive a compensation for impairment or loss. 

When an asset is impaired, lost or given up, any compensation from third
parties is included in profit or loss when the compensation becomes
receivable. [IAS 16:65]

Examples of such circumstances include:

Reimbursements by insurance companies after the impairment or loss of

items of property, plant and equipment (e.g. due to natural disasters, theft
etc.);

Indemnities by governments for items of property, plant and equipment that

are expropriated (e.g. compulsory purchase of land to be used for public
purposes);

 Compensation related to the involuntary conversion of items of

property, plant and equipment (e.g. relocation of facilities from a
designated urban area to a non-urban area in accordance with
government land policy); and

 Physical replacement in whole or in part of an impaired or lost asset.

The Standard emphasises that impairments or losses of items of property,

plant and equipment, related claims for or payments of compensation from
third parties, and any subsequent purchase or construction of replacement
assets are separate economic events and should be accounted for as
such. Netting of transactions is not allowed. The three economic events
should be accounted for separately as follows:
 In respect of impairment or loss:

 Impairments of items of property, plant and equipment should be

recognised in accordance with IAS 36; and

 Derecognition of items of property, plant and equipment retired or

disposed of should be determined in accordance with IAS 16;

 Compensation from third parties for items of property, plant and

equipment that were impaired, lost or given up should be included in
determining profit or loss when it becomes receivable; and

 The cost of items of property, plant and equipment restored,

purchased or constructed as replacements should be determined in
accordance with IAS 16.

Violation of these rule may result to audit reversals which may taint the
competence of the accounting function. 

Derecognition

The Auditors may also test the application of the de-recognition policy.  IAS
16 requires that the carrying amount of an item of property, plant and
equipment should be derecognised:

 On disposal; or

 When no future economic benefits are expected from its use or

disposal.

The reality is that certain organizations still include in the carrying amount of
their PPE, the value of PPE of on which future economic benefits are
reasonably not expected from their use or disposal.  Their documentation
and available facts do not support this assertion.

Substantive procedures for the audit of Non current Assets

1. Obtain/prepare summary of NCA showing. gross book value. accumulated
depreciation. net book value.
2. Reconcile summary with opening position.
3. Reconcile NCA GL (general ledger) with register, obtain explanation about
differences.
4. if no register, obtain schedule with. original cost. depreciated value.
5. reconcile schedule with GL.
Ways to Audit an Accounts Payable File

An accounts payable audit can be the sole focus or a portion of a full internal
audit. General audit strategies are the same, however, regardless of the
reason or reasons for which it’s taking place. AP auditing strategies are
based on fraud risk assessment standards compiled by the Auditing
Standards Board of the American Institute of Certified Public Accountants.
The primary focus is on ensuring accounts payable is neither under- nor
overstated. The process works to ensure invoices and statements as well as
any other liabilities and accrued expenses have been properly calculated and
recorded, whether manually or in a computer accounting program.

Audit for Completeness

Audit procedures regarding completeness fulfill the main auditing objective

and are the most important procedures in the AP auditing process.
Reconciliations, cutoff tests and audit trails are the main ways auditors verify
whether AP documents have been properly calculated and recorded.
Reconciliation procedures determine whether accounts payable ledger
transactions match summary figures in the general ledger. Purchase and
cash disbursements cutoff tests look to see whether transactions for the
fiscal year are indeed included in the business’s end-of-year financial
statements. Audit trails trace and match payments to recorded payables,
looking specifically for open files with unmatched documents.
Audit for Validity

Audit procedures regarding validity work to establish the legitimacy of AP

transactions. The common way auditors establish legitimacy is by reaching
out to vendors and suppliers with transaction confirmation requests.
Although how many and which specific vendors and suppliers receive
requests may vary depending on the business, most send them to all regular
vendors and suppliers regardless of whether there is a current balance due.
In addition, auditors reach out to a percentage of occasional business
partners, usually when records show there are one or more open invoices.
Audit for Compliance

Accounts payable transactions must follow generally accepted accounting

principles. Auditing for compliance determines whether accounting
procedures are in compliance with generally accepted accounting principles.
Auditors often work backward, starting by inspecting end-of-year financial
statements, including the balance sheet, income statement and cash flow
statement, then choose random entries in the general ledger to trace back to
their origin. The audit trail that tracing creates allows auditors to examine
the exact path a transaction took and evaluate accounting procedures.
Audit for Disclosure

Ensuring the AP balance is properly disclosed on end-of-year financial

statements is the final step in the AP auditing process. Ways in which
auditors accomplish this step include inspecting financial statements to
verify, for example, that AP is listed as a current liability and that purchases
are included in cost of goods calculations. Auditors also take notice of
footnotes that provide details for unusual transactions that may require a
more full explanation than can be provided by simply recoding the
transaction. A final way in which auditors verify full disclosure is by reviewing
a mandatory management representation letter attesting that financial
statements fully disclose accounts payable and purchases figures.

RETENTION PAYABLE
Retention is the sum  of amount generally based on certain percentage of Running bill
in terms of construction business. The retention will be the current asset for the
contractor as it is to be received from the contractee in near future and it will be current
liability to the contractee  as it is to be paid to the contractor after successful completion
of the projects or contracts.

Auditing Equity — An Overview

In this post, we will cover the following:
 Primary equity assertions

 Equity walkthroughs

 Equity-related fraud and errors

 Directional risk for equity

 Primary risks for equity

 Common equity control deficiencies

 Risk of material misstatement for equity

 Substantive procedures for equity

 Common equity work papers

More...

Primary Equity Assertions

Before we look at assertions, consider that equity comes in a variety of forms
including:

 Common stock

 Paid in capital

 Preferred stock

 Treasury stock

 Accumulated other comprehensive income

 Noncontrolling interests

 Members’ equity (for an LLC)

 Net assets (for a nonprofit)

 Net position (for a government)

Certain types of equity accounts are used for certain types of entities. For
example, you’ll find common stock in an incorporated business, net assets in
nonprofits, and members’ equity in a limited liability corporation.

The equity accounts used depend upon the type of entity and what occurs
within and outside the organization. Examples include:

 Has an incorporated company purchased treasury stock?

 Does a commercial entity have unrealized gains or losses on available-

for-sale securities?

 Does a nonprofit organization have donor-restricted contributions?

 Does a government have restricted net position?

So, it’s a must--before you determine the relevant assertions--that you

understand the accounting for (1) the type of entity and (2) the particular
equity-related transactions.

Primary relevant equity assertions include:

 Existence and occurrence

 Rights and obligations

 Classification

When a company reflects equity on its balance sheet, it is asserting that the
balance exists and that the equity transactions occurred. For example, if
common stock is sold, the balance of the account is based upon the actual
sale of stock and the monies received. In other words, the balance is not
fraudulently or erroneously stated.
Equity instruments also have certain rights and obligations. For example,
common stock provides rights to retained earnings. Also, some classes of
stock provide voting privileges. Others do not.
Additionally, the classification of equity balances is important. Determining
how to present equity is usually easy, but classification issues arise when an
entity has convertible stock (is it debt or equity?). Another example of a
classification issue is noncontrolling interests (how much of the profits go to
this account?).
Keep these assertions in mind as you perform your transaction cycle
walkthroughs.

Equity Walkthroughs
Early in your audit, perform a walkthrough of equity to see if there are any
control weaknesses. As you perform this risk assessment procedure, what
questions should you ask? What should you observe? What documents
should you inspect? Here are a few suggestions.

As you perform your equity walkthrough ask or perform the following:

 What types of equity does the entity have? What are the rights of each
class?

 How many shares are authorized? How many shares have been
issued?

 Does the company have any convertible debt?

 Has the company declared and paid dividends?

 Are there any state laws restricting distributions?

 Does the company have accumulated other comprehensive income?

 Inspect ownership documents such as stock certificates.

 Read the minutes to determine if any new equity has been issued.

 Is the entity attempting to raise additional capital?

 Has the company sold any additional equity ownership?

 Is there a noncontrolling interest in the company?

 Does the company have stock compensation plan?

 For a nonprofit, are there any restricted donations?

 For a government, is the net position restricted?

 For a limited liability corporation, are there differing classes of

ownership?

As you ask the above questions, consider examining equity-related

information such as stock certificates, receipts from new equity issuances,
general ledger accounts, related journal entries, minutes, and stock
compensation plan documents. Don’t just ask questions. Observe equity
controls (see below) and inspect sample documents. 

As you perform walkthroughs, also consider if there are risks of material

misstatement due to fraud or error.

Equity-Related Fraud and Errors

Theft seldom occurs in the sale of stock. If fraud happens, it’s usually a false
equity presentation. Why? Inflating equity makes the organization appear
healthier than it really is. 

Additionally, mistakes lead to errors in equity accounting. Such mistakes

might occur if the entity sells complex equity instruments. 

So, what is the greater risk for equity? An overstatement or an

understatement?

Directional Risk for Equity

The directional risk for equity is that it is overstated (companies desire strong
equity positions). So, audit for existence. 

Primary Risks for Equity

Primary risks for equity include:

1. Equity is intentionally overstated (fraud)

2. Misclassified equity (error)

As you think about these risks, consider the control deficiencies that allow
equity misstatements.

Common Equity Control

Deficiencies
In smaller entities, it is common to have the following control deficiencies:

 One person performs two or more of the following:

 Approves the sale of equity interests,

 Enters the new equity in the accounting system, 

 Deposits funds from the sale of the equity instruments

 Accounting personnel lack knowledge regarding equity transactions

Another key to auditing equity is understanding the risks of material

misstatement.

Risk of Material Misstatement for

Equity
In auditing equity, the assertions that concern me the most are existence,
classification, and rights. So my risk of material misstatement for these
assertions is usually moderate to high.
My response to the higher risk assessments is to perform certain substantive
procedures: namely, a review of equity transactions. Why?

A company may desire to overstate its equity. Also, misclassifications occur

due to misunderstandings about equity accounting.

Once your risk assessment is complete, you’ll decide what substantive

procedures to perform.

Substantive Procedures for

Equity
1. Summarizing and reviewing all equity transactions

2. Reviewing all equity accounts for proper classification

3. Agreeing all beginning of period balances to the prior period’s ending

balances

4. Reviewing equity disclosures for compliance with the requirements of

the reporting framework (e.g., GAAP)

In light of my risk assessment and substantive procedures, what equity work

papers do I normally include in my audit files?

Common Equity Work Papers

My equity work papers normally include the following:

 An understanding of equity-related internal controls

 Documentation of any equity internal control deficiencies

 Risk assessment of equity at the assertion level

 Equity audit program

 A copy of (sample) equity instruments

 Minutes reflecting the approval of new equity or the retirement of

existing equity

 A summary of equity activity (beginning balances plus new equity less

equity distributions and ending balance)

In Summary
In summary, we’ve reviewed the keys to auditing equity. Those keys include
risk assessment procedures, determining relevant assertions, performing risk
assessments, and developing substantive procedures. The most important
issues to address are usually (1) equity accounting (especially when there are
more complex types of equity transactions) and (2) the classification of equity.

Now that we’ve reviewed the audit of transaction areas, it's time to shift gears.
Next we'll look at how to wrap up the audit. 

HOW TO AUDIT CASH FLOW

First, I’m no GAAP expert. But here is the likely process …

 Cash flow statements are not audited

 Balance sheet balances are typically audited
 Income statements are audited via analytical procedures
 Balance sheet workpapers typically include roll forwards for long-term
assets and liabilities which tie out to the applicable line items on the
cash flow statement
 Net changes in working capital also tie out to the operating cash flow
section
  Finally, the auditors ensure the language is correct on the statement
Accordingly, the cash flow statement is not audited directly. All numbers are the
result of other numbers that have been tested during the audit procedures.
Assertions in the Audit of Financial Statements
Definition
Audit Assertions are the implicit or explicit claims and representations made by the
management responsible for the preparation of financial statements regarding the
appropriateness of the various elements of financial statements and disclosures.

Audit Assertions are also known as Management Assertions and Financial Statement
Assertions.

Topic Contents
1. Definition
2. Explanation
3. Types & Examples
4. Use and Application
5. Purpose & Importance

Explanation
In preparing financial statements, management is making implicit or explicit claims (i.e.
assertions) regarding the recognition, measurement and presentation of assets, liabilities,
equity, income, expenses and disclosures in accordance with the applicable financial
reporting framework (e.g. IFRS).

For example, if a balance sheet of an entity shows buildings with carrying amount of $10
million, the auditor shall assume that the management has claimed that:
 The buildings recognized in the balance sheet exist at the period end;
 The entity owns or controls those buildings;
 The buildings are valued accurately in accordance with the measurement basis;
 All buildings owned and controlled by the entity are included within the carrying
amount of $10 million.

Types & Examples

Assertions may be classified into the following types:

Assertions relating to classes of transactions

Assertion Explanation Examples

s : Salaries
& Wages
 Cost

Occurrenc Transactions recognized in the financial statements have Salaries &

e occurred and relate to the entity. wages
expense
has been
incurred
during the
period in
respect of
the
personnel
employed
by the
entity.
Salaries
and wages
expense
does not
include the
payroll
cost of any
unauthoriz
ed
personnel.

Completen All transactions that were supposed to be recorded have been Salaries
ess recognized in the financial statements. and wages
cost in
respect of
all
personnel
have been
fully
accounted
for.

Accuracy Transactions have been recorded accurately at their Salaries

appropriate amounts. and wages
cost has
been
calculated
accurately.
Any
adjustment
s such as
tax
deduction
 at source
have been
correctly
reconciled
and
accounted
for.

Cut-off Transactions have been recognized in the correct accounting Salaries

periods. and wages
cost
recognized
during the
period
relates to
the current
accounting
period. Any
accrued
and
prepaid
expenses
have been
accounted
for
correctly in
the
financial
statements
.

Classificati Transactions have been classified and presented fairly in the Salaries
on financial statements. and wages
cost has
been fairly
allocated
between:
-Operating
expenses
incurred in
production
activities;
-General
and
administra
tive
expenses;
and
-Cost of
 personnel
relating to
any self-
constructe
d assets
other than
inventory.

Assertions relating to assets, liabilities and equity balances at the period end

Assertions Explanation Examples

:
Inventory
balance

Existence Assets, liabilities and equity balances exist at the period Inventory
end. recognized
in the
balance
sheet
exists at
the period
end.

Completenes All assets, liabilities and equity balances that were All
s supposed to be recorded have been recognized in the inventory
financial statements. units that
should
have been
recorded
have been
recognized
in the
financial
statements
. Any
inventory
held by a
third party
on behalf
of the
audit
entity has
been
 included in
the
inventory
balance.

Rights & Entity has the right to ownership or use of the recognized Audit
Obligations assets, and the liabilities recognized in the financial entity
statements represent the obligations of the entity. owns or
controls
the
inventory
recognized
in the
financial
statements
. Any
inventory
held by the
audit
entity on
account of
another
entity has
not been
recognized
as part of
inventory
of the
audit
entity.

Valuation Assets, liabilities and equity balances have been valued Inventory
appropriately. has been
recognized
at the
lower of
cost and
net
realizable
value in
accordanc
e with IAS
2
Inventories
. Any costs
that could
not be
reasonably
allocated
 to the cost
of
production
(e.g.
general
and
administra
tive costs)
and any
abnormal
wastage
has been
excluded
from the
cost of
inventory.
An
acceptable
valuation
basis has
been used
to value
inventory
cost at the
period end
(e.g. FIFO,
AVCO,
etc.)

Assertions relating to presentation and disclosures

Assertions Explanation Examples:

Related
Party
Disclosures

Occurrence Transactions and events disclosed in the financial statements Transactions

have occurred and relate to the entity. with related
parties
disclosed in
the notes of
financial
statements
 have
occurred
during the
period and
relate to the
audit entity.

Completeness All transactions, balances, events and other matters that All related
should have been disclosed have been disclosed in the parties,
financial statements. related
party
transactions
and
balances
that should
have been
disclosed
have been
disclosed in
the notes of
financial
statements.

Classification & Disclosed events, transactions, balances and other financial The nature
Understandability matters have been classified appropriately and presented of related
clearly in a manner that promotes the understandability of party
information contained in the financial statements. transactions,
balances
and events
has been
clearly
disclosed in
the notes of
financial
statements.
Users of the
financial
statements
can clearly
determine
the financial
statement
 captions
affected by
the related
party
transactions
and
balances
and can
easily
ascertain
their
financial
effect.

Accuracy & Transactions, events, balances and other financial matters Related
Valuation have been disclosed accurately at their appropriate amounts. party
transactions,
balances
and events
have been
disclosed
accurately at
their
appropriate
amounts.

Use and Application

Auditors are required by ISAs to obtain sufficient & appropriate audit evidence in respect of
all material financial statement assertions. The use of assertions therefore forms a critical
element in the various stages of a financial statement audit as described below.

Stage of Audit Application of Assertions

Planning As part of the risk assessment procedures, auditors are required to understand the
entity and its environment including the assessment of the risk of material
misstatement (ROMM) due to fraud and error at the financial statement and
assertion level. (ISA 315.3 )

The assessment of ROMM at the financial statement and assertion level provides
 the basis for determining the nature, timing and extent of audit procedures that
are necessary to obtain sufficient and appropriate audit evidence in response to
those assessed risks. (ISA 200.A36)

Testing Substantive tests are performed to identify material misstatements at the

assertion level. In case of assertions whose ROMM has been assessed as significant
and no tests of control are planned to be performed, the substantive procedures
should include tests of detail (i.e. substantive analytical procedures alone cannot
be considered as sufficient and appropriate audit evidence for assertions with a
significant risk of material misstatement. (ISA 330.21)

Tests of control (TOCs) are performed to assess the operating effectiveness of

controls at the financial statement and assertion level. TOCs are necessary to
validate the auditor's expectation of the operating effectiveness of controls (as
acquired from the risk assessment procedures performed at the planning stage)
and also in case where the performance of substantive procedures alone cannot
provide sufficient and appropriate audit evidence in respect of a specific assertion.
(ISA 330.8)

Completion Auditor shall conclude whether sufficient and appropriate audit evidence has been
obtained for all material financial statement assertions taking into account any
revisions in the assessment of ROMM at the assertion level. (ISA 330.25-6)

Where an auditor is unable to obtain sufficient and appropriate audit evidence in

respect of a material financial statement assertion, he is required to modify the
audit report accordingly. (ISA 330.27)

Purpose & Importance

Assertions assist auditors in considering a wide range of issues that are relevant to the
authenticity of financial statements. The consideration of management assertions during the
various stages of audit helps to reduce the audit risk.
Timing of Audits

Petty cash audits should be conducted randomly and without notice to other
employees. Without random audits, employees who are “borrowing” from petty cash
for personal reasons have time to put the money back in place before you audit the
funds.
Total the Contents

Balancing the petty cash in the box or drawer is the first step in auditing. The total of
all petty cash plus the receipts for items petty cash was used to pay for should equal
the total amount of petty cash held for use. For example, if you maintain $500 in petty
cash and have $150 in receipts for petty cash expenses, you should have $350 in
cash remaining in the drawer. Unaccounted for money or receipts should be noted in
an audit report, and all employees with access to petty cash should be questioned
about the difference.