MGTD60H3 Chapter 10 Substantive Testing and Balance Sheet Accounts

Transcription

1 Intrductin: - Objectives f substantive testing - The factrs that affect the nature, timing, and extent f prcedures - Prcess that impact significant accunts in the BS - Illustrative prcedures fr auditing the significant accunts 10.1 Relatinship between Risk Assessment and Substantive Prcedures - Substantive prcedures are als called substantive testing r test f details - Substantive prcedures are audit prcedures designed t detect material misstatement at the assertin level Extent f Substantive Prcedures - Extent f substantive prcedures depends n the risk assessment fr each significant accunts - Accunts that are clearly trivial and immaterial are ignred r nly subjected t analytical prcedures - Analytical Prcedures are evaluatins f financial infrmatin made by a study f plausible relatinships amng bth financial and nn-financial data It encmpasses the investigatin f identified fluctuatins and relatinships that are incnsistent with ther relevant infrmatin r deviate significantly frm predicted amunts - Prfessinal judgement is critical and it is influenced by factrs such as materiality, the nature f the accunt balance r disclsure, and the risks identified - Risk assessment is determined using the audit risk frmula (inherent risk, cntrl risk, and detectin risk) - If inherent and cntrl risks are assessed as lw, substantive testing is needed - If inherent and cntrl risks are assessed as medium r mderatin, a cmbinatin f tests f cntrls and substantive prcedures are required Timing f Substantive Prcedures - Timing depends n the risk assessment f the significant accunt r disclsure in questin Significant accunt is an accunt r grup f accunts that culd cntain material misstatements based n their materiality and/r relatinship t identified inherent and FS risks - The higher the detectin risk fr an accunt, the less wrk is needed t be perfrmed, and a greater reliance n the tests f cntrl befre year end is placed - The lwer the detectin risk, the mre wrk is needed t be perfrmed, with the majrity f evidence being btained by perfrming substantive prcedures near r at year end - Factrs influencing timing f wrk perfrmed: Reviewing events ccurring prir t year end Majr business acquisitins r dispsals

2 Key charges t expense accunts (payrll bnuses) Majr fixed asset additins r dispsals Reviewing the activity in the perid t date Mnthly review f the aging f TR Perfrming general audit prcedures prir t year end Accumulatin f knwledge thrughut the year Review f bard minutes, jurnal entries, and legal crrespndence Perfrmed at interim date with an update at year end Reviewing prvisins prir t year end Familiarizatin with the apprach taken by management prir t year end s the auditr can begin t develp an expectatin f the balances in advance f the year end visit 10.2 Substantive Testing f Cash - Presented as single line item n the BS - Cnsists f cash n hand, cash in the bank, and cash equivalents - Cash Equivalents are highly liquid investments that can be quickly cnverted int cash - Imprest Payrll Accunts are accunts established fr prcessing payrll disbursements nly - Cash balance presented as a liability is called Bank Indebtness which happens when a firm has access t a bank verdraft facility and has spent mre cash n hand - 3 (and 1 extra) imprtant assertins regarding cash: Existence Verified by the receipt f a cnfirmatin frm the bank Bank shuld als cnfirm whether they are any additinal accunts, lans, pledges, lease facilities, r ther banking facilities Cmpleteness (balance cmpletely reflects all cash transactins) Testing bank recnciliatin by vuching any differences between cash as per the bank statement and cash as per the general ledger t supprting dcumentary evidence Fees and interests shuld be vuched t the general ledger as evidence that client has recnciled the items Difference between vuching a bank statement and a general ledger is ften the result f cheques that have been issued but have nt yet cleared the bank Classificatin Additinal infrmatin related t cash accunt that is required t be disclsed in the FS Unused credit facilities and ther infrmatin that is part f the cash flw statement disclsure requirements Rights and Obligatins Clients might have pledged assets such as cash (cash restrictin) Valuatin and Allcatin is nt as imprtant but nly in situatins where clients have freign exchange transactins

3 Principal Objectives in Auditing Cash - Nte that classificatin assertin is different frm classificatin and understandability assertin - Classificatin and understandability assertin relates t the presentatin and disclsure in the FS, while classificatin refers t transactins and events that ccur thrughut the year (hw they are recrded and if they are recrded in the right accunt) 1. All cash n the BS is held by the entity r by thers (bank) fr the entity (E) 2. All cash wned by the entity at year end is included in the BS (C) 3. Cash is stated at its realizable value (VA) 4. Entity wns r has legal rights t all the cash n the BS at year end (RO) 5. Cash is prperly classified, described, and disclsed in the FS including all ntes and restrictins in accrdance t IFRS/GAAP (CL and CU) Factrs Impacting the Audit f Cash - Testing perfrmed at an interim stage ver cash receipts and disbursements - If cntrls are effective, n additinal test f cntrl is required t be perfrmed - Thus, the auditr wuld perfrm substantive tests t audit cash at year end with n additinal prcess r cntrl related testing required - Mst transactins flw thrugh the cash accunt at sme pint and therefre cash is qualitatively material - Cash tends t have high inherent risk if an rganizatin has a large number f cash transactin during the year - Cash is the easiest t steal - Analytics ver the cash accunts are generally nt used because cash is cnsidered lumpy and unstable - Prcedures can be perfrmed as part f cntrl test (dual) - Example f substantive tests f transactins cash: CASH RECEIPTS PROCESS Prf f cash by: - Recnciling activity per client rectrs t activity per bank - Crrelate these transactins t the activity in the sales and TR ledgers - C, A Cmpare remittance advices r lists f cash receipts with entries in the cash receipts jurnal - CL, C - Cmpare the details f duplicate depsit slips with entries in the cash receipt jurnal - Investigate abnrmal delays in CASH PAYMENTS PROCESS Accunt fr the numerical sequence f cheques issued during a specified perid - C, CO (Cut-ff) - Cmpare paid cheques and dcuments with the cash disbursement jurnal - Check if dcuments cnfirm it has been paid - C Cmpare entries in cash jurnal with paid cheques and supprting dcuments - O (Occurrence)

4 depsiting cash receipts - C - Cmpare ttal amunts f daily depsits shwn in the bank statement with ttals in the cash receipt jurnal - Investigate unusual delays - C - Agree invice amunts t cash received fr cash sales transactins - Agree cash cllected t the recrded cash balance and dcument - C - Test the recrding miscellaneus receipts in the TR jurnal - See if the amunt is reasnable - A Cmpare entries in the cash jurnal with the remittance advice, etc - O Test accunting classificatin f receipts - CL, VA Test math accuracy - A Test authrizatin f credits, discunts, and allwances - O, E Test the accunt classificatins f cash payments - CL Test the math accuracy f the cash disbursement jurnal - VA Test the pstings f the ttals in the cash disbursement jurnal t general ledger and subsidiary ledgers - C Test psting f individual cash payments frm the cash disbursements jurnal - CL Determine if signatures n paid cheques are authrized - A Illustrative Prcedures fr Auditing Cash - Testing perfrmed at an interim stage - Tests perfrmed t cnfirm cash held by thers and in hand: Ft the bank recnciliatin t ensure math accuracy Trace the balance t general ledger Agree cnfirmed balance Obtain cut ff bank statement Determine whether utstanding cheques have subsequently cleared and depsit in transit has been recrded by the bank Verify the apprpriateness f recnciling items - Other example f prcedures: Review cash accunts fr unusual item Review bank cnfirmatins, minutes f meeting, and lan agreements Recalculate freign currency accunts Prepare a schedule f cash transfer befre and after year end Cunt cash n hand Cmmn Evidence Internally and Externally

5 - Internally: GL, recnciliatins, and minutes f BOD, and ther - Externally: Bank statements, bank cnfirmatins, cheques, depsit slips, and bank agreements 10.3 Substantive Testing f Trade Receivables (TR) - Tw audit assertins imprtant when TR is significant: Existence Verified by sending cnfirmatins t the client s custmers Psitive cnfirmatin nly prvides evidence abut the balance wing PC des nt prvide assurance that custmers will pay the balance wing Best way t ensure that the balance is valued crrectly is by the full receipt f the cash by the client at year end Valuatin and Allcatin Additinal test is required called Subsequent Receipts A sample f TR at year end is vuched t the subsequent receipts Used when auditr did nt get any cnfirmatin frm client s custmer Supprting dcument indicates an apprpriate cut ff and the custmer paid the accunt after year (which means it existed) This assertin is tested when the allwance fr dubtful accunts is reviewed and recalculated Additinal analytical prcedures are als perfrmed t cmpare the aging f TR frm prir year Classificatin is als imprtant because f additinal infrmatin that needs t be disclsed Rights and Obligatins may be imprtant fr thse clients wh are restricted by trade terms as part f its cnditins f sale (sale n cnsignment) Nte n Cnfirmatins - Must assess the reliability f cnfirmatin - Respndent has t be independent f the client - Sme respndents d nt understand what is being requested - Sme replies withut verifying the balance - Cnfirmatins are sent t thse with the largest and ldest balances utstanding - If client has a number f smaller AR, auditr picks a sample - Sme d nt use cnfirmatins because f past histry f gd recrds and risk is lw - Auditr must get the client s cnsent befre sending ut cnfirmatins (cnfidential) - If client refuses, find ut the reasn f the refusal Principal Objectives in Auditing TR 1. All receivables n the BS are real claims f the entity (E) 2. All real claims f the entity fr AR are included in the BS (C)

6 3. Receivables are carried at their NRV (VA) 4. Entity wns and has legal rights t all AR n the BS at year end (RO) 5. Receivables are prperly classified, described, and disclsed in the FS (CL and CU) Prcess Impacting n TR - Sales Prcess - Sales Return and Allwances Prcess (Credit Mems) - Cash receipts prcess Illustrative Prcedures fr Auditing TR - Tests always perfrmed: Cnfirm AR If exists, cnfirm rll frward f activity frm the cnfirmatin date t year end Investigate unusual items Examine subsequent cash receipts Test cut ff Inspecting the sales ledger, billings, shipping dcuments, and ther files befre year end Evaluate the adequacy f the allwances f dubtful accunts Scan the general ledger fr unusual items Investigate all exceptins nted n cnfirmatins - Analytical prcedures perfrmed: Allwances fr dubtful accunts Cmmn Evidence Internally and Externally - Internally: GL, recnciliatins, and analysis - Externally: Bank statements, receipts, cheques, depsits, and AR cnfirmatins 10.4 Substantive Testing f Inventry - Inventry Listing is the list f all the items f inventry used t capture purchases and sales f inventry (inventry sub ledger) - 2 assertins: Existence Physically bserving/cunting (t see hw many and if they are defective) Valuatin and Allcatin Recrd at carrying value r fair value Typical substantive test t test valuatin is the initial cst recrded (by vuching t invice), value recvered fr any sales (by vuching t sale invices), and any prvisin fr impairment r bslete stck n hand at year end

7 Cmpleteness is nt a majr issue because we are typically cncerned with verstating assets but imprtant if there is sale n cnsignment Rights and Obligatins is imprtant regarding gds in transit (FOB) Principal Objectives in Auditing Inventry 1. All inventry n IL is included in the FS (E) 2. All inventry wned at year end is n the BS (C) 3. Inventry is carried at FV (VA) 4. Entity wns and has legal rights t all inventry n the BS (RO) 5. Inventry is prperly classified, described, and disclsed (CL and CU) Prcess Impacting n Inventry - Inventry Prcess - Cash payments prcess - Purchases prcess Illustrative Prcedures fr Auditing Inventry - Tests always perfrmed: Observe the cunting f physical inventry t establish that: Persnnel is in cmpliance with inventry cunt instructins Items belnging t client are accurately cunted and recrded Items nt included are excluded Cunt tags, sheets, and cards are prperly cntrlled - Analytical prcedures perfrmed: Inventry turnver frm prir perids Cmparer last year s COGS Cmmn Evidence Internally and Externally - Internally: GL, recnciliatins, analysis, cunt instructins, and cunt tags/sheets - Externally: Cntracts/agreements, purchase rders, receiving dcuments, and invices 10.5 Substantive Testing f PPE - Fixed Asset Register r Cntinuity Schedule A register f listing f all PPE items - 2 assertins: Existence Physically lking at the assets listed in the FAR in the first year the a client is audited In fllwing years, the fcus is n additins r dispsals Lk at assets peridically t see if there are assets that are damaged r bslete

8 Valuatin and Allcatin Recrd at carrying value r fair value Test fr valuatin fcuses n initial cst recrded (vuching t invices), value recvered frm sale (by vuching t cash received r trade-in amunts), and depreciatin and impairment f assets Rights and Obligatins are tested during the first year f audit Can be verified thrugh supprting papers r agreements Principal Objectives in Auditing PPE 1. All PPE n BS are held by the entity r by thers fr the entity (E) 2. All PPE wned r lease under capital leases at year end are included n the BS (C) 3. PPE is carried at FV and at apprpriate accunting perid (VA) 4. Entity wns all PPE (RO) 5. PPE is prperly disclsed and classified (CL and CU) Prcess Impacting n PPE - Cash receipts - Cash payments - Purchasing prcess Illustrative Prcedures fr Auditing PPE - Tests always perfrmed: Examine invices, capital expenditure authrizatins and ther dcuments abut additins r dispsals Review and when apprpriate examine supprting dcuments fr significant charges t repairs r maintenance t determine if it shuld be capitalized r nt Recalculate depreciatin fr accuracy - Analytical prcedures perfrmed: Cmpare prir perid and apprve capital expenditure budgets Review depreciatin expense - Other prcedures: Test calculatin f capitalized interest Determine tax basis Examine lease agreements (financing vs. perating) Assess unusual additins Inspect evidence f wnership Review minutes and agreements fr evidence f plans f cmmitments t future additins 10.6 Substantive Testing f Payables - 2 key assertins: Cmpleteness Risk is that balance is understated

9 Subsequent Payments Testing and Cut-ff Testing are tests t search fr unrecrded payables SP invlves vuching a sample f payments made after year end t supprting invices t ensure that if the amunt relates t invices dated prir t year end, they have been crrectly included in payables at that date CT invlves selecting a sample f purchases made n either side f year and end and verifying that each has been crrectly included r excluded frm payables based n the invice date Valuatin and Allcatin Classificatin is imprtant if there are related party transactins - Accruals (amunts that clients may have nt received the invice fr but they knw they have an bligatin t pay ut as at year end) - Use the SP t test accruals - Vuch accrual amunt t invices received Principal Objectives in Auditing Payables 1. All payables n BS are real debt payable (E) 2. All payables wed by the entity are included n the BS (C) 3. All AP are stated at the amunts wed at year end (VA) 4. All payables represent an bligatin (RO) 5. AP is prperly disclsed and classified (CL and CU) Prcess Impacting n Payables - Cash payments prcess - Purchasing prcess Illustrative Prcedures fr Auditing Payables - Tests always perfrmed: Examine client s bank recnciliatins Test cut ff by inspecting cash disbursements Perfrm a search fr unrecrded liabilities at year end by selecting subsequent payments - Analytical prcedures perfrmed: Prir perid cmparisn Cmpare the # f days purchases in AP with prir year - Other prcedures: Identify cllateral fr AP Review debit mems and ther similar adjustments at year end Cmmn Evidence Internally and Externally - Internally: Authrizatin apprvals, meeting minutes, GL, analysis, and recnciliatins

10 - Externally: Cntracts/agreements, purchase rders, receiving dcuments, and invices Special Cnsideratins fr Auditing ther BS Accunts - These accunts are typically audited fully substantive (with limited r n test f cntrls) because they are easier t audit at year end - Prepayments Audited by vuching the balance t supprting invices Ensuring that the split between what has been expensed and what remains in the BS is crrect - Investments Vuched either t supprting external dcumentatin (investment statement) Vuched t share prices per the stck exchange Vuched t supprting FS - Intercmpany Balances - Taxatin Balances Need a tax specialist - Prvisins - Leases (finance and perating) Operating leases are nt n the BS and are typically disclsed nly - LT Liabilities If new debt is issued, assess minutes f BOD fr evidence f authrizatin and btain a debt agreement - Equity Audit Evidence Summary - 6 evidence cllectin techniques used t design audit prcedures: 1. Recalculatin/re-perfrmance (auditr s calculatins) (mre n amrtizatin) 2. Observatin (auditr s bservatins) (bservatins in cntrls d nt necessarily prve existence) 3. External cnfirmatin (statements by independent parties) (auditr s respnsibility t mail cnfirmatins) 4. Inquiry (statements by client persnnel) (usually n bank lan) 5. Inspectin (dcuments and tangible assets) (invice, cntracts, and agreements) Vuching (existence and ccurrence) Tracing (cmpleteness) Scanning (eyes-pen apprach fr searching unusual items) 6. Analysis