Piotr Pyziak, Consultant, CFRR 16 March 2017, Vienna Audit Training of Trainers Road to Europe: Program of Accounting Reform and Institutional Strengthening EU-REPARIS is funded by the European Union and is a part of WB EDIF.
»Discuss substantive testing objectives for selected accounts»engage in a group exercise based on the scenario of the simulated audit client case PejaSko to design substantive tests for:» Property, Plant and Equipment» Receivables» Cash and Bank» Revenues» Cost of Sales 2
» Substantive procedure (ISA 330) An audit procedure designed to detect material misstatements at the assertion level. Substantive procedures comprise:» (i) Tests of details (of classes of transactions, account balances, and disclosures); and» (ii) Substantive analytical procedures.» Substantive testing is used by auditors to obtain audit evidence. 3
Analytical procedures Test of detail (balances & transactions) 4
» Key areas when testing tangible non-current assets:» Confirmation of ownership,» Inspection of non-current assets,» Valuation by third parties,» Adequacy of depreciation rates,» Potential impairment. Financial statement assertion Existence and occurrence Completeness Rights and obligations Accuracy, classification and valuation Assertions relating to presentation and disclosure Audit objective Additions represent assets acquired in the year and disposal represent assets sold or scrapped in the year Recorded assets represent those in use at the year-end All additions and disposals that occurred in the year have been recorded All assets in use at the year-end are included in balances The entity has rights to the assets purchased and those recorded at the year-end Non-current assets are correctly stated at cost less accumulated depreciation Additions and disposals are correctly recorded Review any impairment indicators, test or impairment Disclosures relating to cost, additions and disposals, depreciation policies, useful lives and assets held under finance leases are adequate and in accordance with accounting standards 5
» Completeness & existence Physical verification» Valuation» Verify valuation to valuation report and consider reasonableness» Evaluate depreciation rates (in terms of lives of assets, residual amounts, gains/losses on disposal, consistency in accounting policies, replacement policy)» Compare ratios of depreciation to non-current assets» Review capitalisation of expenses for additions» Review labour, material and overhead costs for self-constructed assets, search for any profit element, review capitalisation of finance costs. 6
» Rights and obligations» Verify title to land and buildings by inspection of title deeds or registry certificates, and give special consideration to leases agreements.» Inspect registration documents for vehicles» Classification and understandability» Review disclosures to ensure they meet IFRS for SMEs requirements» Contractual commitments, restrictions on title, temporary idle, fully depreciated but still in use 7
»Potential issues for PejaSko:» Physical existence and counting of live stock» Depreciation rate estimates» Low valuation of land and buildings 8
» Key areas when testing inventories:» Cut-off,» Inspection of inventories,» Valuation - obsolescence,» Adequacy of depreciation rates. Financial statement assertion Existence and occurrence Completeness Rights and obligations Valuation Presentation and disclosure Audit objective Recorded inventory exists at the year-end All inventory is included in the balance at the year-end The entity has rights to disclose the balances of inventory at the year-end Proper cut-off procedures are applied for disclosing the right balance Recorder value of inventories is fairly stated Disclosures relating to cost, valuation, including potential provision for obsolescence are adequate and in accordance with accounting standards 9
»Existence & Completeness»Physical verification participation at the year-end count of inventories»rights and obligations»apply cut-off procedures to verify ownership of inventories reconcile shipments to goods dispatch notes and sales invoices (Does inventory at year-end belong to PejaSko or clients?). 10
»Valuation»Review and assess reasonableness of valuation of inventories. Apply analytical procedures comparisons of value and quantity to prior periods. Include in the process review of provision for inventories.»review the cost elements of valuation allocated: labour, material and overhead costs or any other costs elements used in the process of valuation of inventories. 11
»Potential issues for PejaSko:» Physical existence and counting of inventory» Issue with proper valuation proper absorption of costs» Cut-off of inventories - returned inventory after year end» Provision for obsolete inventories - returned inventory after year end 12
» Key assertions related to audit of receivables:» existence,» completeness and» valuation» Tested in conjunction with sales where key assertions are:» occurrence,» completeness and» accuracy.» Combination of test of details and analytical procedures 13
» Completeness» Trace shipping documentation to invoice and to recorded sales in sales and receivables ledger.» Comparison of gross profit % with industry and prior years.» Existence» Circularisation and follow-up with supported explanations for differences or alternative procedures» Rights and obligations» Bank confirmations for any liens on receivables, inquiries to management, inspection of loan agreements, review of board minutes for evidence of possible factoring. 14
» Valuation and allocation» Compare aged analysis with prior year or industry, including bad debt expense% of sales and allowance as % of credit sales or receivables.» Confirm adequacy of allowance by reviewing correspondence with solicitors or customers» Discuss allowance % with management» Cut-off» Review material after year end credit notes and adjustments» Analytical procedure on sales returns.» Review before year end invoices and trace to documentation for dispatch. 15
»Presentation and disclosure:» Relating potential provision for doubtful/bad debt in accordance with accounting standards 16
»Potential issues for PejaSko:» Receivable for reimbursement from Insurance Claim» Distinction between receivables from big retail chains and small buyers what are the payment patterns?» Dependency on few major clients (going concern?)» The ageing of receivables potential cash flow issue?» Doubtful vs bad debt - the need for provision for receivables? 17
Financial statement assertion Existence Completeness Rights and obligations Valuation Assertions relating to presentation and disclosure (classification and understandability, occurrence and rights and obligations, accuracy and valuation, completeness) Audit objective Recorded cash balances exist at the period-end Recorded cash balances include the effects of all transactions that have occurred The entity has legal title to all cash balances shown at the period-end Recorded cash balances are realisable at the amounts stated Disclosures relating to cash are adequate and in accordance with accounting standards and legislation 18
» Bank balances» Key audit procedure for bank balances is confirmation (attention to cut-off issues).» Covering all assertions (existence, completeness, cut-off, valuation and allocation, rights and obligations).» Decide which bank balances to be confirmed, all of them usually.» Note details of accounts or leave blank.» Single confirmation requesting information on all loans and deposits including other important information regarding disclosures (i.e. guarantees, restrictions on bank accounts)» Review bank reconciliations if applicable (for cheques, transfers of cash with different value date).» Verify bank balances with standard bank statements 19
»Cash in Hand» Carefully audited if balances are material and susceptible to fraud (hotels, restaurants, retail organisations)» Auditors will be concerned that the cash exists, is complete, and belongs to the company (rights and obligations) and is stated at the correct value.» Plan for locations to attend the cash count at year end» Obtain all reports/certificates on cash counts and compare with accounting records» Follow-up on banked cash receipts and reconcile with bank statements after cut-off date 20
»Potential issues for PejaSko:» Dormant bank account» Lack of segregation of duties concerning cash payments» Chairmen travel costs 21
» The major issue is understatement of liabilities» Completeness» Test subsequent cash disbursements» Circularization (blank positive confirmation, small and zero balances sampled)» Test of unmatched purchase orders and suppliers invoices received for unrecorded liabilities» Disclosure checklists» Analytical procedures on payables turnover, payables days, sample supplier balances and compare to prior year data.» Rights and obligations» Vouch sample of balances to supporting documentation: invoices, receipt notes and purchase orders.» Valuation and allocation» Vouch sample of balances to supporting documentation: invoices, receipt notes and purchase orders.» Recalculate accruals. 22
» Cut-off» Test transactions around the year-end to determine whether amounts have been recognised in the correct financial period.» Perform analytical procedures on purchase returns, comparing the purchase returns as a % of sales or cost of sales to the previous year.» Classification and understandability» Review the trade accounts payables listing to identify any large debits» Read the disclosure notes relevant to liabilities in the draft financial statements 23
»Potential issues for PejaSko:» Payables relating to the personal trips of the owner» Timely payments of payables threatened by slow collection of receivabels cash flow issue and additional costs of external operational financing 24
Substantive tests Test the year-end cutoff of sales transactions verify the sales invoices from end of the audited year and begining of next year to shipping documents and terms of the contract. Test sale returns post year end verify goods received shipping documents and documents correcting sales, which were issued in the beginning of next year. Perform analytical procedures on revenue compare to prior years, compare month by month, investigate margins: monthly, by product, by client, etc. Audit objectives Cut-off, Completeness Occurrence Accuracy Review significant year-end sales contracts and discounts - inquire about and examine the volume based discounts granted to supermarkets. 25
Substantive tests Evaluate accounting estimates related to revenues Audit objectives Accuracy Investigate sale transactions with related parties Evaluate financial statement presentation and disclosure Cross reference confirmation tests from receivables section Presentation and disclosure Existence, occurrence, and rights, valuation 26
»Potential issues for PejaSko:» Revenues could be overstated before year end with corrections to sales in the next reporting period» Existence of volume based discounts and the proper reflection in FS 27
Substantive tests Test the year-end cutoff of purchase transactions (both goods and services) verify the purchase invoices from end of the audited year and begining of next year to relevant shipping documents and to revelant contract agreements, service orders or other documentation. Verify major purchases of services during the year to supporting documentation, including the contracts. Inquire the nature and relevance of these. Perform analytical procedures on cost of sales compare to prior years, compare month by month, investigate margins: monthly, by product, by client, etc. Investigate big and unusual items. Audit objectives Cut-off, Completeness Occurrence Accuracy 28
Substantive tests Evaluate accounting estimates related to cost of sales Audit objectives Accuracy Investigate purchase transactions from related parties Evaluate financial statement presentation and disclosure Cross reference confirmation tests from payables section Presentation and disclosure Existence, occurrence, and rights, valuation 29
»Potential issues for PejaSko:» Cost of sales could be understated cost transactions could be pushed to the next reporting period in order to improve the results of audited year.» The nature and amounts of private expenses of the owner needs to be investigated with detail (potential tax implications). 30
Substantive tests Review employment contracts with latest annexes. Verify amounts from the contracts to payroll list and payroll slips. Verify calculation of relevant social charges and taxes, reconcile to tax returns. Verify accounting entries and payments of payroll and relevant taxes and social charges to bank account. Audit objectives Occurrence, Accuracy, Completeness Occurrence, Accuracy Classification, Accuracy, Cut-off 31
Substantive tests Perform analytical procedures on payroll and related social charges and taxes compare to prior years, compare month by month, investigate margins: monthly, by product, by client, etc. Investigate bid and unusual items. Evaluate financial statement presentation and disclosure Audit objectives Accuracy Presentation and disclosure Cross reference confirmation tests from payables section and cost of sales Existence, occurrence, and rights, valuation 32
»Potential issues for PejaSko:» Cost of payroll and related taxes and social charges could be understated gray economy.» Payroll and related social charges and taxes could be wrongly calculated risk of tax control, possible penalties and interest. 33
»Use template 11 to perform design substantive tests based on the PejaSko Case study for:» Property, Plant and Equipment» Receivables» Cash and Bank» Revenues» Cost of Sales»Work in Groups for 15-20 minutes»each Group will present the results 35