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1 Chapter 9: Audit procedures
When you have completed this chapter you will be able to:
1 General principles
We dealt with the principles of audit evidence in an earlier chapter. This chapter deals with the application of those principles.
It is a starting point to help you familiarise yourself with the basic auditing techniques to allow you to apply them to questions. It is not an exhaustive summary of all audit tests,
this would simply not be possible in one volume.
The objective of audit testing is to assist the auditor in coming to a conclusion as to whether the financial statements are free from material misstatement.
However, the auditor does not simply design tests with the broad objective to identify material misstatement. This is a difficult conclusion to reach and can only be based upon a
series of detailed tests, each designed with a specific testing objective relating to certain areas of the financial statements.
For example: auditors have to assess whether inventory balances are free from material misstatement. Unfortunately, there are many ways inventory could be misstated:
Each of these concerns could result in misstatement, which ultimately could (alone or in aggregate) be material.
For this reason auditors have to perform a range of tests on the significant classes of transaction, account balances and disclosures to be reasonably sure that they are not
misstated. These tests focus on what are known as financial statements assertions:
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Occurrence – did the transactions and events recorded actual occur and pertain to the entity?
Completeness – have all transactions, assets, liabilities and equity interests been recorded that should have been recorded?
Accuracy – have amounts, data and other information been recorded and disclosed appropriately?
Cut-off – have transactions and events been recorded in the correct accounting period?
Classification and understandability – have transactions and events been: recorded in the proper accounts; and described and disclosed clearly?
Rights and obligations – does the entity hold or control the rights to assets and are liabilities the obligations of the entity?
Valuation and allocation – are assets, liabilities and equity interests included in the financial statements at appropriate values?
When the auditor designs further audit procedures they must ensure that they test a range of the assertions listed. For transactions (i.e. incomes and expenses recorded in the
income statement) the auditor should test:
occurrence;
completeness;
accuracy;
cut-off; and
classification
For accounts balances (i.e. those balances recorded on the statement of financial position) the auditor should test:
existence;
rights and obligations;
completeness; and
valuation and allocation.
Whilst the testing of accounts balances and transactions will probably be the focus of the audit, the auditor must also design tests to ensure that transactions, balances and other
relevant information/matters are appropriately disclosed in the financial statements. Assertions relevant to the disclosures are:
occurrence;
rights and obligations;
completeness;
classification and understandability; and
accuracy and valuation.
To assist your studies and simplify this process consider the following four questions that an auditor needs to answer when approaching testing:
(1)Should items be in the accounts at all? (occurrence, existence, rights and obligations, cut-off).
A further warning
In the sections that follow, we will consider specific audit areas and suggest how these are usually tested. You may be tempted to learn these tests and repeat them 'parrot
fashion' in the exam. This would be unwise. Audit procedures are designed to reflect the unique risks of an audit and the nature of items and assertions under scrutiny. You must
always try and make your answers specific to any scenarios presented in the exam. This requires both knowledge and application skills.
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Key assertions
Audit procedures
Existence
Perform a receivables circularisation ( a direct confirmation from external sources - see below).
Select a sample of receivables and trace amounts due to the original sales invoice to confirm that a transaction has taken place;
Receivables circularisation;
Select a sample of receivables and confirm the trade terms to original credit agreements and sales invoices.
Inspect the ageing profile of receivables to identify any significant, long outstanding balances that may require a provision.
Analytically review the ageing profile in comparison to previous periods to identify any deterioration in credit control.
Inspect post year-end cash book/bank statements and trace payments received to year-end receivables to confirm that amounts were indeed collectable.
Discuss the results of the ageing and cash receipts analysis with management to identify if any further provisions are required for old, unpaid balances.
Discuss the assumptions underlying any general provisions with management to ensure they are appropriate.
Recalculate the provision based on management’s assumptions and agree to the figure in the financial statements.
Inspect invoices relating to prepaid balances, agree cost to calculations made.
Inspect bank statements to confirm prepaid amounts have been paid.
Completeness
Obtain a list of receivables balances, cast this and agree it to the receivables control account total at the end of the year. Differences should be reconciled.
Perform a receivables circularisation.
Inspect receivables ledger for credit balances and obtain explanations from management.
Inspect a sample of the last five to ten goods despatched notes immediately prior to the year-end. Trace these through to year-end receivables to ensure they have been
recorded.
Inspect the draft financial statements and agree the receivables figures and disclosures to nominal ledger balances.
Also note the effect of directional testing, e.g. directly testing receivables for overstatement also indirectly tests revenue for understatement (Dr: Receivables, Cr:
Revenue).
Receivables circularisations
If successful, circularisations provide evidence directly from the receivables themselves. These are considered to be reliable because they are external, third party confirmations.
Circularisations are also written and original.
Procedure
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The auditor investigates any disagreement by receivables.
Considerations
Whilst circularisations are undoubtedly a useful and efficient tool for providing good quality evidence, their success does depend on response rates. It must be remembered that
the audit client's customers are under no obligation to reply and, for this reason, responses may be limited. If the response rate is poor then other forms of evidence must be
sought. To maximise the response rate auditors should ensure:
Customer Ltd
Customer’s address
Date of circularisation
Dear Sirs
As part of their normal audit procedures we have been requested by our auditors, Auditor & Co, to ask you to confirm the balance on your account with us at 31 December 2009,
our year-end.
The balance on your account, as shown by our records, is shown below. After comparing this with your records will you please be kind enough to sign the confirmation and return
a copy to the auditor in the prepaid envelope enclosed. If the balance is not in agreement with your records, will you please note the items making up the difference in the space
provided.
Please note that this request is made for audit purposes only and has no further significance.
Yours faithfully
Auditor & Co
Auditor’s address
Dear Sirs
We confirm that, except as noted below×, a balance of $10,000 was owing by us to Client Limited at 31 December 2009.
×Details of differences:
Key assertions
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Principles
A typical inventory count happens at the year-end, although continuous counting is possible throughout the year.
The purpose of the count is to confirm that the quantities of inventory recorded on the client's system are accurate.
Whilst the count is being performed items that are damaged and/or obsolete should be identified for either scrapping or sale at a discounted price.
From an audit perspective, attendance at the count helps provide evidence regarding the existence, completeness and valuation of inventory balances.
Inventory counting is the responsibility of the client. The auditor merely attends the count to help gather evidence to form an opinion regarding whether inventory is free from
material misstatement or not.
Obtain the client's counting instructions and review them for obvious flaws in the counting process. This may also help identify if there are any significant or risky elements of
inventory that require special attention, or even precautions.
The procedures suggested above apply to all inventory counts, whether as a one-off, year-end exercise or where inventory is counted on a rolling basis throughout the year. The
objective is the same:
To identify whether the client's inventory system reliably records, measures and reports inventory balances.
Where the client uses a continuous counting system lines of inventory are counted periodically (say monthly) throughout the year so that by the end of the year all lines have
been reviewed. There are both advantages and disadvantages of this for the auditor.
Advantages
The auditor is less time constrained and can pick and choose particular locations and inventory lines to count at any time to ensure the system is reliable.
Slow moving and damaged inventory should be identified and adjusted for in the client's records on a continuous basis therefore, thus improving the valuation at the year-
end.
Disadvantages
The auditor will need to gain sufficient evidence that the system operates effectively at all times, not just at the time of the count.
Additional procedures will need to be devised to ensure that the year-end inventory total is reliable, particularly with regard to cut-off and year-end provisions/estimates.
Where the client has inventory at locations not visited by the auditor, the auditor normally obtains confirmation of the quantities, value and condition from the holder. The
auditor needs to consider whether the holder is sufficiently independent to be able to provide relevant, reliable evidence.
As with confirmations from receivables, the auditor requests details from the party holding the inventory on behalf of the client to confirm its existence.
The confirmation request will be sent by the client to those parties identified by the auditor.
The reply should be sent directly to the auditor to prevent it being tampered with by the client.
Problems can occur if the third party uses a different description to that of the client and as always, a response is not guaranteed.
Completeness
Obtain an inventory list showing each line of inventory categorised between finished goods, WIP and raw materials. Cast the list to ensure it is arithmetically correct. Make
sure the totals agree to amounts disclosed in the financial statements.
Trace the items counted during the inventory count to the final inventory list to ensure it is the same as the one used at the year-end and to ensure that any errors identified
during counting procedures have been rectified.
Cut-off
Trace the GRN's from immediately prior to the year-end (identified during the count) to year-end payables and inventory balances.
Trace the GDN's from immediately prior to the year-end (identified during the count) to the nominal ledgers to ensure the items were removed from inventory prior to the
year-end and have been recorded in receivables prior to the year-end.
Inspect the financial statements and ensure that the figures disclosed agree to the audited nominal ledger balances and that inventories have been correctly analysed
between finished goods, raw materials and work in progress.
Valuation
Trace a sample of inventory items back to original purchase invoices to agree their cost.
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Trace a sample of inventory items to post-year-end sales invoices to determine if the appropriate cost or net realisable value has been used.
Inspect the ageing of inventory items to identify any old/slow moving amounts that may require provision.
Trace the above items to any inventory provisions and, if they have not been provided, discuss the reason with management.
Recalculation of work in progress and finished goods using payroll records for labour costs and utility bills for overhead absorption.
Calculate inventory turnover/days and compare to last year to assess whether inventory is being held longer and therefore requires greater provisions.
Calculate gross profit percentage and compare to prior year to identify any significant fluctuations that may indicate either error or changes in inventory holding policies.
Key assertions
Completeness is usually the key consideration when testing payables due to the timing and nature of the items included. Provisions and accruals accounting do offer an
opportunity for creative accounting to manipulate reported profits. Auditors therefore have to consider indicators that additional liabilities may exist, such as:
payables not including known major suppliers and those accrued for in the prior year;
payables not including the significant suppliers from the equivalent list last year;
traditionally recurring accruals not being made, e.g.: rent, utilities, telephone, etc.
expected finance accruals not being made, e.g.: hire purchase, mortgages, loans etc.
non-provision of tax balances, including: corporation tax, payroll taxes, sales taxes, etc.
suppliers revealed only after a review of payments after the year-end; and
suppliers revealed by a review of unpaid invoices at and after the year-end.
Inspect financial statements to ensure that all liabilities from the nominal ledger have been adequately and accurately disclosed.
Existence
Circularise a sample of trade payables to confirm the balance at the end of the year (this is uncommon and would only be performed in the absence of supplier statements).
Inspect year-end statements of accounts sent by suppliers. Any differences between the statement and the nominal ledger should be reconciled.
Trace a sample of payable/accruals balances to purchase invoices and/or contracts. In particular identify the date of receipt of the invoice and any evidence of payment (such
as signatures).
Completeness
Cut-off
Select a sample of GRN's raised immediately prior to the year-end and trace them through to year-end payables.
Likewise, select a sample of GRN's raised immediately after the year-end and trace them to the nominal ledger to ensure they have been recorded in the next accounting
period.
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Again, note the effect of directional testing, e.g. directly testing payables for understatement also indirectly tests expenses/cost of sales for understatement (Dr:
Expenses/Cost of sales, Cr: Payables).
Supplier statements
Companies may send out monthly statements of account as part of their credit control procedures. Therefore it is likely that audit clients will receive a number of these
statements from suppliers at the year-end. These can be reconciled to their own payables control account to ensure that their records are correct. This is known as a supplier
statement reconciliation and is an important source of audit evidence. Like most statements sent through the post there are a number of reasons why there may be variances:
(1)Timing differences:
Invoices sent by the supplier but not yet received by the client.
Payments sent by the client but not yet received by the supplier.
Returns and credit notes not yet appearing on the supplier’s statement.
(2)Errors
Supplier errors that will remain as part of the reconciliation until the supplier corrects them.
Client errors, which the client needs to adjust.
Auditors can inspect or reperform the supplier statement reconciliations to ensure the completeness, existence and valuation of payable balances. They are a reliable source of
evidence because they are produced by the suppliers, who are (usually) independent, external sources (but note suppliers may be related parties/intergroup companies, and
therefore not independent).
Accruals
Inspect invoices received after the year-end that relate to services provided before the year-end. Trace them to any accruals made to ensure completeness and accuracy of
the amounts.
Obtain the list of accruals from the client, cast it to confirm arithmetical accuracy.
Agree the figure per the schedule to the general/nominal ledger and financial statements
Recalculate a sample of accrued costs by reference to contracts and payment schedules (e.g. loan interest).
Analytically review in comparison to previous period to try and identify if any balances are perhaps missing.
Tax balances
Agree details to underlying agreement/contracts and recalculate interest amounts and the split between current and non-current.
Loan payables
Agree the year-end loan balance to any available loan statements to confirm obligations, existence and valuation.
Agree interest payments to the loan agreement and the bank statements.
Analyse relevant disclosures of interest rates, amounts due (e.g. between current and non-current payables) to ensure complete and accurate.
Recalculate the interest accrual to ensure arithmetical accuracy.
Provisions are a form of payable where the amount or timing of payment is uncertain. As such they are harder to audit.
Where the likelihood of payment is only possible, rather than probable, no amounts will be entered in the accounts. However, the matter (contingent liability) must be
adequately disclosed.
Discuss the matter giving rise to the provision with the client to verify whether an obligation exists.
Obtain confirmation from the clients lawyers as to the possible outcome and probability of having to make a payment.
Review subsequent events. By the time the final audit is taking place the matter may have been settled.
Obtain a letter of representation from the client as the matter is one of judgement and uncertainty (see 'Completion' chapter for further discussion).
Recalculate the provision if possible, e.g. warranty provisions for repairs.
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Key assertions
This is a direct confirmation of bank balances from the bank that gives the auditor independent, third-party evidence.
The format of the letter is usually standard and agreed between the banking and auditing professions.
Issues covered are:
the client’s name
the confirmation date
balances on all bank accounts held
any documents or other assets held for safekeeping
details of any security given
details of any contingent arrangements – guarantees, forward currency purchases or sales, letters of credit.
The auditor needs the client to give the bank authorisation to disclose the necessary information (in some jurisdictions such disclosures are illegal so bank letters cannot be
used at all).
Ensure that all banks that the client deals with are circularised.
The balances for each account should be agreed to the relevant bank reconciliation at the year end;
Details of loans should be agreed to the disclosure in the statement of financial position as either current or non-current.
1 January 20X1
Dear Sir,
In accordance with the agreed practice for provision of information to auditors, please forward information on our mutual client 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.
Information required
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Other information (see attached)
The Authority to Disclose Information signed by your customer is already held by you. This is dated 30/08/X0. Please advise us if this Authority is insufficient for you to provide
full disclosure of the information requested.
Yours Faithfully,
Obtain a list of all bank accounts, cash balances and bank loans and overdrafts and agree to totals to figures included in current assets and current liabilities in the financial
statements.
Obtain a copy of the client's bank reconciliation, cast and agree the balances to the cash book and bank letter.
Trace all outstanding lodgements and unpresented cheques to pre-year-end cash book and post-year-end bank statements.
Ensure all accounts in the bank letter are included in the financial statements.
Ensure bank loans and overdrafts are not offset against positive bank balances in the financial statements.
Count the petty cash in the cash tin at the end of the year and agree the total to the balance included in the financial statements.
Inspect the draft financial statements and ensure that amounts are disclosed correctly as either assets (positive balances) or liabilities (overdrafts) and that the amounts
recorded agree to the nominal ledger.
Key assertions
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Valuation and allocation – assets are included in the financial statements at the correct amount;
Completeness – all assets have been accounted for.
Classification and understandability – assets are appropriately disclosed in the financial statements?
Existence
Select a sample of assets from the non-current asset register and physically inspect them.
Completeness
Select a sample of assets visible at the client premises and inspect the asset register to ensure they are included.
Examine the repairs and maintenance accounts in the general ledger for large and unusual items that may be capital in nature. These should be included in the statement of
financial position, not expenses.
Valuation
Disclosure
Key assertions
Share capital
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Agree authorised share capital and nominal value disclosures to underlying shareholding agreements, such as company memorandums, articles of association and lists of
registered members;
Inspect cash book for evidence of cash receipts from share issues;
Inspect terms of share certificates and reconcile to cash receipts and new share capital totals;
Inspect board minutes to identify if any dividends have been declared prior to the year-end;
Directors' remuneration
Reserves
Reconcile closing profit reserves to: opening reserves, profit for the year and dividend paid and proposed during the year;
Compare opening reserves to closing reserves reported in the prior year's financial statements;
Reconcile movements in revaluation reserves to the non-current asset register;
Corroborate revaluations by comparing to independently produced reports.
9 Accounting estimates
Accounting estimates are of particular concern to the auditor as, by their nature, there may not be any physical evidence to support them and they are prone to inaccuracy. They
are also subjective and therefore prone to management bias. If the directors wished to manipulate the accounts in any way, accounting estimates are an easy way for them to do
this. The auditor must take care when auditing estimates to ensure this has not been the case.
In accordance with ISA 540 Auditing Accounting Estimates auditors need to obtain an understanding of:
How management identifies those transactions, events and conditions that give rise to the need for estimates; and
How management actually makes the estimates, including the control procedures in place to minimise the risk of misstatement.
In response to this assessment auditors should perform the following further procedures:
Review of the outcome of the estimates made in the prior period (or their subsequent reestimation);
Consider events after the reporting date that provide additional evidence about estimates made at the year-end;
Test the basis and data upon which management made the estimate (e.g. review mathematical methods);
Test the operating effectiveness of controls over how estimates are made;
Develop an independent estimate to use as a point of comparison; and
Consider whether specialist skills/knowledge are required (e.g. lawyer).
Smaller entities
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Smaller commercial entities will usually have the above attributes. This can lead to both advantages and disadvantages:
Lower risk: Smaller entities may well be engaged in activity that is relatively simple and therefore lower risk. However, this will not be true for small – often one person
businesses – where there is a high level of expertise in a particular field, e.g. consultancy businesses, creative businesses, the financial sector.
Direct control by owner managers is a strength because they know what is going on and have the ability to exercise real control. They are also in a strong position to
manipulate the figures or put private transactions ‘through the books’.
Simpler systems: Smaller entities are less likely to have sophisticated IT systems, but pure, manual systems are becoming increasingly rare. This is good news in that many
of the bookkeeping errors associated with smaller entities may now be less prevalent. However, a system is only as good as the person operating it.
Evidence implications
The normal rules concerning the relationship between risk and the quality and quantity of evidence apply irrespective of the size of the entity.
The quantity of evidence may well be less than for a larger organisation.
It may be more efficient to carry out 100% testing in a smaller organisation.
Problems
Management override – Smaller entities will have a key director or manager who will have significant power and authority. This could mean that controls are lacking in the
first place or they are easy to override.
No segregation of duties – Smaller entities tend to have few accounts clerks that processes information. To overcome this the directors should authorise and review the
all work performed.
Less formal approach – Smaller entities tend to have simple systems and very few controls due to the trust and the lack of complexity. It is therefore difficult to test the
reliability of systems and substantive testing tends to be used more.
Not-for-profit organisations
Not for profit (NFP) organisations include charities and public sector entities. The most important differences from privately owned companies are that NFP entities:
do not have profit maximisation as their main objective. These will be either social or philanthropic;
do not have external shareholders; and
will not distribute dividends.
Some NFP entities, particularly small charities, may have weaker systems due to:
lack of segregation of duties, as the organisation will be restricted with the amount of staff;
the use of volunteers, who are likely to be unqualified and have little awareness of the importance of controls;
the use of less formalised systems and controls.
Significantly, with many charities, much of the income received is by way of donation. These transactions will not be accompanied by invoices, orders or despatch notes.
Assessing the going concern of a NFP entity may also be more difficult, particularly for charities who are reliant on voluntary donations. Many issues, such as the state of the
economy, could impact on their ability to generate revenue in the short term.
Audit implications
Auditors of not for profit organisations will be required to assess whether the aims of the organisation are being met in an economic, efficient and effective manner. For this
reason "value for money" audits are much more appropriate. These are discussed in more detail in the internal audit chapter.
Testing tends to concentrate on substantive procedures where control systems are lacking. In the absence of documentary evidence procedures rely heavily on analytical review,
enquiry and management representation.
The volumes of transactions in not for profit organisations may be lower than a private one, therefore auditors may be able to test a larger % of transactions.
Ultimately, if sufficient appropriate evidence is not available the auditor will have to modify their audit report.
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List and explain FOUR assertions from ISA 315 Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment that relate to
the recording of classes of transactions.
List FOUR assertions relevant to the audit of tangible non-current assets and state one audit procedure which provides appropriate evidence for each assertion.
(a)Define 'tests of control' and explain why they are an important procedure in the statutory audit of any company.
(4 marks)
You are an audit senior working at a medium sized firm of auditors. One of your clients is an exclusive hotel called ‘Numero Uno’ situated in the centre of Big City. As part
of your audit procedures you are assessing the controls surrounding payroll. You have read last year’s audit file and have obtained the following information:
The hotel employs both full and part time staff. Due to the nature of the business most of the work is done in shifts. All staff are paid on a monthly basis.
New members of staff are given an electronic photo identification card on the day they join by the personnel department. This card is used to ‘clock in’ and ‘clock
out’ at the start and end of the shift to record the hours worked.
At the end of each week the information recorded on the system is sent automatically to the payroll department and also to the head of each of the three main operating
divisions: Rooms, Food & Beverage and Corporate Events. Each division head must reply back to the payroll department by email to authorise the hours worked by their staff.
The payroll clerk collates all the authorised information and then inputs the hours worked into a standardised computerised payroll package. This system is password protected
using an alphanumerical password that only the payroll clerk and the finance manager know.
Once the hours have been inputted, the calculations of gross pay and taxation are calculated automatically along with any other statutory deductions. At the end of the
calculations a payroll report is produced and printed. The finance manager reviews the report and compares the data to last month to identify and follow up any unusual
variances. When he is satisfied with the information he authorises the payroll run by signing the payroll report and the payroll clerk submits the data.
Payslips are sent to the home address of each employee and payment is made by bank transfer.
‘Numero Uno’ prides itself on delivering a first class dining experience and is renowned for its standards of service and cooking that few restaurants in the country come
close to. Its inventory therefore consists of the very best foods and beverages from across the globe.
Food products held in inventory are mostly fresh as the head chef will only work with the very best ingredients. ‘Food’ inventory is stored in the kitchens and managed by
the head chef himself.
The majority of beverages held at the hotel are expensive wines that have been sourced from exclusive vineyards. The hotel also stocks a wide range of spirits and mixers. All
beverages are stored either in the hotel cellar or behind the bar. The cellar can only be accessed by the duty manager who holds the key. As part of your audit procedures you
will attend the year end inventory count of the hotel’s beverages.
Required:
(i) Identify and explain FOUR STRENGTHS within the hotel’s internal control system in respect of payroll.
(6 marks)
(ii) For each of the identified strengths, state a test of control the auditor could perform to assess if the controls are operating effectively.
(4 marks)
(c)Describe the audit procedures an auditor would conduct before and whilst attending the inventory count of the beverages in the hotel.
(8 marks)
(d)Identify and explain THREE financial statement assertions that are most relevant to inventory.
(3 marks)
(e)Apart from attending the inventory count, describe the substantive procedures an auditor would carry out to confirm the valuation of the wine and spirits held in inventory at the
year end.
(5 marks)
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(Total: 30 marks)
(a)Describe the steps an auditor should take when conducting a trade receivables confirmation (circularisation) test.
(4 marks)
(b)Explain why a direct confirmation test may not provide sufficient appropriate audit evidence on its own.
(3 marks)
You are the audit manager in charge of the audit of Builders Mate, a limited liability company. The company’s year end is 31 March, and Builders Mate has been an audit
client for three years. Builders Mate sells small tools, plant and equipment exclusively to the building trade. They have 12 warehouse style shops located throughout the country.
Builders Mate does not manufacture any products themselves.
The audit fieldwork is due to commence in 3 weeks time and you are preparing the audit work programme for the trade receivables section of the audit. Extracts from the clients
trial balance show the following information.
From your review of last year’s audit file you have determined that last year there were 2 specific provisions of $5k and $2k as well as a 3% general provision.
Initial conversations with the client indicate that there are no specific provisions that are to be made this year however they intend to reduce the general provision from 3% to 2%.
You are aware that two of Builders Mate’s major customers went into administration during the year and they are likely to be liquidated in the near future. Both of these
customers owed material amounts at the year-end.
Required:
(c)Describe substantive procedures the auditor should perform on the year-end trade receivables of Builders Mate.
(9 marks)
(d)Describe how audit software could facilitate the audit of trade receivables.
(4 marks)
(Total: 20 marks)
10 Chapter summary
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Occurrence: The transactions and events that have been recorded have actually occurred and pertain to the entity.
Completeness: All transactions and events that should have been recorded have been recorded.
Accuracy: The amounts and other data relating to recorded transactions and events have been recorded appropriately.
Cut-off: Transactions and events have been recorded in the correct accounting period.
Classification. Transactions and events have been recorded in the proper accounts.
Completeness: ensure that all non-current assets are recorded in the non-current asset register by agreeing a sample of assets physically verified back to the register.
Existence: ensure non-current assets exist by taking a sample of assets from the register and physically seeing the asset.
Valuation and allocation: ensure assets are correctly valued by checking the reasonableness of depreciation calculations.
Rights and obligations: ensure the company owns the asset by seeing appropriate document of ownership for example, a purchase invoice.
Presentation and disclosure assertions: ensure all necessary financial statements disclosures have been made by reviewing the financial statements.
(a)Tests of control
A test of control tests the operating effectiveness of controls in preventing, detecting or correcting material misstatements.
It is important for the external auditor to test controls to ensure their initial understanding obtained when assessing the control environment and internal controls is appropriate.
This will allow the auditor to identify and assess the risks of material misstatements in the financial statements and to determine to what extent to rely on the internal control
system during the audit.
The auditor will then be able to design sufficient and appropriate substantive audit procedures to reduce detection risk, and therefore audit risk, to an acceptable level.
Strengths in the control environment at the hotel in respect of payroll are set out below including the test of control to be performed by the auditor.
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Review prior year working papers to understand the inventory count process and identify any issues that would need to be taken into account this year.
Contact Numero Uno (client) to obtain stocktaking instructions for this year to understand how the count will be conducted and assess the effectiveness of the count
process.
Book audit staff to attend the inventory count.
Ascertain whether any inventory is held by third parties and if applicable determine how to gather sufficient audit evidence.
Consider the need for using an expert to assist in valuing the inventory being counted. There may be some speciality wines and spirits that require expert valuation.
Observe the count to ensure that the instructions are being followed.
Inspect the bottles being counted for evidence of damage or obsolescence that may affect the net realisable value and hence overall valuation of inventory.
Perform a test count. Select a sample of beverages from the inventory count sheets and physically observe the items in the cellar or bar to confirm they exist.
Perform a test count. Select a sample of physical beverages from the cellar or bar and trace to the inventory count sheets to ensure that they are recorded accurately and
therefore that the records are complete.
Record cut off information by obtaining details of the last deliveries prior to the year end. This information will be used in final audit procedures to ensure that no further
amendments have been made thereby overstating or understating inventory.
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(d)Inventory assertions
(e)Substantive procedures
Quantity
For the audit test counts performed during the inventory count trace and agree the quantities to the final inventory records to ensure the integrity of the data.
The beverages should be valued at the lower of cost and net realisable value.
For a sample of beverages on the inventory records, trace the cost of those items to the original purchase invoice, ensuring that the description of goods on the invoice
matches the beverage.
For beverages sold to customers after the year end, check a sample of restaurant bills/invoices back to the final inventory records ensuring that the sales value exceeds the
cost. Where sales value is less than cost, ensure that the beverage is stated at the realisable value.
For high value items such as Champagne, vintage wine and exotic spirits use an expert valuer to review the net realisable value of a sample of items to ensure the value is
reasonable.
Inventory noted during the count as possibly obsolete or damaged should be traced to the inventory records to ensure the valuation has been adjusted to take this into
account. The expert valuer may provide assistance with these valuations.
Several steps should be performed by an auditor when performing a trade receivables circularisation audit test:
Audit client approval should be obtained in advance to perform the direct confirmation test of trade receivables.
The population for the sample should be determined and a suitable sample selected using an appropriate sampling technique.
The confirmation letter should be designed and prepared for each receivable ensuring the contact details are correct and return details clearly state that the reply should be
made direct to the auditor.
A business reply envelope, addressed to the auditor, could be included for this purpose.
The sending of letters, including any follow-up requests, should be controlled and performed by the auditor to ensure the integrity of the test.
Replies should be matched or reconciled to the audit client’s receivables accounting records.
Alternative audit procedures will be required for all non-responses to the confirmation letter.
Several factors influence the sufficiency of evidence gathered during a direct confirmation of trade receivables and other evidence may be required by an auditor to form an
opinion in this area:
There is often a low response rate from trade receivables meaning that other audit procedures will be required for these balances.
The type of confirmation letter, whether a positive or negative confirmation request, will influence the sufficiency of evidence gathered. Negative confirmations provide less
persuasive audit evidence than positive confirmations and it is unlikely that a negative confirmation will provide sufficient evidence on its own.
The reliability of the responses to the confirmation requests may be in doubt for example if there is a risk of fraud being perpetrated.
Mistakes and errors may be present in the accounting records of the trade receivables confirming the balance outstanding.
Trace and agree the receivables balances on the trial balance to Builders Mate’s accounting system and the draft financial statements.
Confirm the trade receivables control account balance matches the sum of the individual trade receivables ledger accounts.
For a sample goods dispatched notes around the year-end trace to the sales invoice and ledger accounts to ensure that the transactions have been recorded in the correct
accounting period.
Cast a sample of trade receivable ledger accounts to confirm arithmetical accuracy.
Select a sample of individual trade receivables and perform a direct confirmation test using a positive confirmation letter.
For non-responses to the direct confirmation test confirm cash has been received post year-end for the outstanding amounts.
Cash receipts recorded in the trade receivables ledger account should be traced and agreed to their remittance advice as well as the cash book and bank statements.
Recalculate the general provision based on the 2% figure to ensure arithmetical accuracy.
Discuss with the Builders Mate management why the general provision has reduced from 3% to 2% and assess the reasonableness of the explanations provided.
Obtain or prepare an aged receivables analysis to identify aged debts that may require a specific provision. Discuss with management any such balances and ensure specific
provisions are made if appropriate.
Trace and confirm that the specific provisions made in the prior year were either written off or the cash was recovered in the current accounting period.
Discuss with management the reason for not making specific provisions for the two customers in administration who owe material amounts at the year-end.
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Consider and discuss with management the potential implications of failing to make specific provisions on the audit opinion.
Compare a sample of individual trade receivables to their prior year balance and investigate any unusual or unexpected changes between the balances.
(d)Audit software
Audit software can be used to improve the effectiveness and efficiency of the audit process of trade receivables.
Audit software can be used to prepare an aged receivables analysis and to identify potential irrecoverable debts using a range of criteria set by the auditor.
It can analyse the receivables ledger for credit balances or negative balances.
Audit software will be more efficient and accurate at casting and recalculating figures, totals and balances such as the general provision or casting of the receivables ledgers.
It could also select a sample for testing and prepare direct confirmation letters.
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