1

Assertions are categorised as follows :

 assertions about classes of transactions and events for period under audit e.g. sales, interest received
 assertions about account balances at year-end e.g. accounts receivable, property, plant and equipment
 assertions about presentation and disclosure e.g. notes that support Statement of Financial Position account
headings, contingent liabilities

Transactions and events : Account balances : Presentation & disclosure :

 Occurrence – have all  Existence – assets,  Occurrence and rights and
occurred and pertain to the liabilities and equity interest obligations – have occurred
entity exist and pertain to entity
 Completeness – anything  Rights and obligations –  Completeness – all has
that should have been entity holds and controls been included
recorded has been recorded rights to assets and  Classification &
 Accuracy - have been obligations are theirs understandability – is
recorded appropriately  Completeness – have all appropriately presented and
 Cut-off - have been been recorded described and disclosures
recorded in the correct  Valuation and allocation – are clearly expressed
accounting period included at appropriate  Accuracy and valuation –
 Classification - have been amounts and valuation or disclosed fairly & at
recorded in the correct allocation adjustments are appropriate amounts.
accounts recorded

Assertions for Statement of Financial Position transactions and balances :

Assertion Audit objective - to obtain satisfaction that :
Completeness individual transactions and balances in respect of specific kind of asset or liability are fully
accounted for in the accounting records and financials
Valuation & the balance for the specific asset or liability has been accounted for at the appropriate carrying
allocation value and that the transactions have been correctly allocated to the proper period and recorded
at the proper amount
Existence at a given date the asset or liability did exist and the transactions did take place during the
period in question
Rights & at a given date the asset or liability pertains to the entity and that the transactions did take
obligations place during the period in question
Presentation & the asset or liability was disclosed, classified and described in accordance with the applicable
disclosure legal requirements and generally accepted accounting practice
Assertions for Statement of Comprehensive Income transactions and balances :
Assertion Audit objective - to obtain satisfaction that the specific revenue or expenditure :
Completeness transactions and balances are fully accounted for in the accounting records and financial
statements
Occurrence  transactions actually took place during the period in question (occurrence)
 transactions pertain to the entity (validity)
Cut-off / accuracy / transactions are recorded in the proper period, are correctly allocated and are recorded at the
classification proper amount

Presentation & balances are disclosed, classified and described in accordance with the applicable legal
disclosure requirements and generally accepted accounting practice (ISA’s & 4th schedule)
2

Procedures used by auditor to obtain audit evidence :

Analysis of objectives Procedures of auditor
Completeness :
All transactions were recorded at the time when they - check date on the supporting documentation
took place

All transactions have been reported in the accounting - check sequential numbering of transactions
records

Occurrence :
- investigate existence of valid documents
Transactions reordered in records did actually take - compare entries in accounting records with supporting
place documents
- check that transactions have been authorised

Transactions recorded in the accounting records - check supporting document to ensure that entity was party in
pertain to the entity the transaction

Existence :
- perform physical inspection of assets and compare it with the
Assets and liabilities did actually exist on given date accounting record
- examine supporting documentation
- obtain supporting evidence from 3rd parties

Accuracy / cut-off / classification :

All transactions have been recorded at the proper - compare the amount from supporting documents with the
amount amount in the accounting records

All transactions have been correctly allocated - compare the allocation with the particulars in the supporting
documents
All transactions have been recorded in the correct - compare the date of the transaction with the date on the
financial period supporting documentation

Valuation :
Assets and liabilities have been recorded at an - obtain external valuation or confirmation from 3rd parties
appropriate carrying value

Assess value by physical inspection - compare value by referring to supporting documentation

Assess the reasonable of the amounts claimed for

reduction / increase or write-off of assets

Rights and obligations :

- examine supporting documentation
Assets and liabilities pertain to the entity at a given
date - obtain evidence from 3rd parties in support of rights or
obligations

- obtain sufficient information to make sure that the state of

affairs was applicable at given date

Presentation and disclosure :

Items in financials have been correctly disclosed, - examine financials and obtain satisfaction that there has
classified and described been proper disclosure, classification and description in
terms of the Companies Act and generally accepted
accounting practice
3

APPLICATION CONTROLS
Framework for application controls in computerised environment =
 masterfile amendments
 input, processing and output
 validity, accuracy and completeness
 prevention, detection and correction.
Ideal to have distinctive input, processing and output phases with manual controls combined with program controls, but if
fewer people involved and if no real distinction between these phases then must place more reliance on :
 access controls and programmed controls rather then manual controls
 preventative rather then detective and corrective controls
Vital that the information that is being processed is valid, accurate and complete.
Application = set of procedures and programmes that satisfy all users associated with a specific task.
Application controls = controls over input, processing and output of financial information relating to specific application,
that ensures that the information is valid, accurate and complete. Consist of both automated (computerised) and manual
controls.
Transaction files = files uses to store all details of an individual transaction
Masterfiles = files used to store only standing information (debtor’s names, addresses and credit limits) and latest balances.
Masterfile amendments = changes to standing data on masterfiles – MUST be tightly controlled
Objective of controls in computerised accounting environment is generally centered around the validity, accuracy and
completeness of data and information processed by and stored on the system.
Validity = ensures that the transactions and data :
 aren’t fictitious or fraudulent and
 are in accordance with activities which have been properly authorised by management
Accuracy = minimising errors to ensure that data and transactions are correctly captured, processed and allocated
Completeness – ensuring data and transactions are not omitted or incomplete
Terms relating to the stage at which controls are implemented to achieve the objectives explained above :
 prevention = controls designed to identify errors and problems in source data and how it is captured BEFORE it is
accepted for input, processing and output by the system
 detection = controls which identify errors and problems with data that has been entered onto the system (i.e. errors that
weren’t caught by prevention controls). Detection is worthless unless problems are followed up on and resolved
 correction = controls that are implemented to resolved errors and problems which have been identified using detection
controls.
4

AUDIT OF BALANCES IN THE FINANCIALS (verification)

Company Auditor
Generates ledger balance Checks opening balances in the ledger

Company Auditor
Generates trail balance Recalculates arithmetical correctness of ledger balances and
makes sure the balance agrees with the amount in the TB

Company Auditor
Generates balances in the private ledger Compares list of balance with balances in the private ledger

Company Auditor
Reconciles total of the list of balances with the Compares total of the list of balances with balance of control
control account in the general ledger account and checks that the control account recon is correct.
Investigates any abnormalities that may occur in the account
balances by applying CAAT’s

Company Auditor
Applies cut-off procedures Checks correct cut-off procedures were applied

Company Auditor
Accounts for financial information according to Tests compliance with stated accounting policy
stated accounting policies

Company Auditor
Compares tangibles with accounting records Conducts physical inspection of tangible assets and compares
with the account records

Auditor
Other procedures : o examines subsequent events after Statement of Financial
Position date
o does ratio analyses
o obtains appropriate representations from management
o carries out specific procedures to obtain external audit
evidence
o applies CAAT’s

Company Auditor
Drafts financial statements Checks disclosure in financial statements
5
STUDY TOPIC 5

THE AUDIT OF TRANSACTIONS AND BALANCES

Financial statements assertions and the revenue & receipts cycle

Sales transactions :
 actually occurred (not fictitious) and they pertain to the entity (occurrence)
 recorded at correct amount (accuracy) and are allocated in proper accounting period (cut-off)
 have all been recorded (completeness) in the proper accounts (classification)

Receipts (transactions) :
 payment from debtor actually occurred and pertains to entity (occurrence)
 receipts are recorded at correct amount (accuracy) and are allocated to the proper accounting period (cut-off)
 all receipts have been recorded (completeness) in the proper accounts (classification)

Debtors and bank / cash balances (account balances) :

 debtors and bank balances actually existed at Statement of Financial Position date (existence)
 company has rights to the debtors and bank balances i.e. not encumbered in any way – and if they are encumbered
then the disclosure has been made (rights)
 all debtors and bank balances are including at Statement of Financial Position date (completeness)
 debtors have been reflected at appropriate carrying value i.e. suitable allowance has been made for recovery of non-
recoverable debts (valuation) and bank balances are carried at their correct value (valuation)

Presentation and disclosure :

 In addition to above also that presentation and disclosure of all matters pertaining to balances and transactions in this
cycle are complete and that the financial reporting standards have been correctly classified and accurately presented
and disclosed in an understandable way.

Cos audit objective is something that has to be achieved important start answer with “to obtain satisfaction that …” when
discussing formulation of an audit objective.
e.g. if listing audit objectives for audit of accounts receivables that are disclosed as part of current assets in BS of entity
would say :
 to obtain satisfaction that the accounts receivable balances have been fully accounted for in the account records and
financial statements (completeness)
 to obtain satisfaction that the accounts receivable balances have been accounted for at an appropriate carrying value
(valuation)
 to obtain satisfaction that accounts receivable actually existed at year-end (existence)
 to obtain satisfaction that accounts receivables pertain to the orgaisation at year-end (rights and obligations)
 to obtain satisfaction that have been correctly disclosed, classified and described in the financials (presentation and
disclosure)

Characteristics of good internal control with relevance to the revenue and receipts cycle :
 control environment – receipts, banking and debtors controls must be very strong. Debtors cannot be just written off
or deleted instead of paying
 competent trustworthy personnel – anyone who has access to cash or cheques
 segregation of duties – division of duties between person receiving payment from customers, person banking the cash
and person writing up the records and reconciling the bank account. Should also be someone independent of all these
who handles the debtor’s queries. Person who maintains debtor’s records should be independent of person who
authorises adjustments to debtors accounts (e.g. credit notes)
 isolation of responsibilities – all documents in the cycle should be initialed to indicate a control has taken place,
especially :
 when credit worthiness checks have been carried out on orders before they are processed
 as goods move from one function to another and are checked as being received by signing document
 when cheque payments move from the mailroom to the cashier, and even more so when there is cash
 access / custody control – physical control over payments (cashier should be protected and chqs should be protected
by being crossed). Access to debtor’s ledger should also be restricted cos if debtor’s records are destroyed doubtful
company will be able to collect. Also to prevent false credit notes being passed and the money stolen
 source document design – e.g. numbering, control over blank forms and limited information that can be keyed in etc
 comparison and reconciliation – must frequently and timeously check :
 orders placed by customers to orders processed / invoiced
 invoices to payments received (debtor’s maintenance)
 debtor’s ledger to general ledger
 cash records to bank statement
6
Important account aspects of the revenue and receipts cycle
ISA18 provides guidance on the recognition of revenue. Especially if assessed risk that sales are overstated, then the
auditor must confirm that the following conditions have been met for the sale to be correctly recognised :

sale of goods :  significant risks and rewards of ownership have been transferred from seller to buyer
(e.g. signed delivery note or contract with legal title transfer
 seller doesn’t retain continuing managerial involvement or effective control over the
goods that have been sold (e.g. consignment stock sent to an agent is not a sale until
the agent has sold the goods)
 amount of revenue can be measured reliably (i.e. sales values reflected on the invoice)
 probable that economic benefits associated with the transaction will flow to the entity (not
fictitious sales)

rendering of services  amount of revenue can be measured reliably (e.g. contract rates and payment terms are
specified in a contract between two entities
 probably that economic benefits associated with the transaction will flow to the entity
 stage of completion of the transaction can be measured reliably at the Statement of
Financial Position date (e.g. by stage of completion can be measured by percentage of
costs incurred to date in fulfillment of the contract against the total estimated costs of the
contract)
allowance for doubtful  if any uncertainly arises about the collectability of an amount already included as
debts revenue then it must be expensed and NOT revenue adjusted and reduced.

Tests of control
 observation
 enquiry
 inspection
 reperformance
To prepare a program of tests of controls in any cycle, first need to identify the controls and then select a suitable
procedure. e.g. :
 enquire if all orders are directed to order clerk and if he makes out internal sales orders for all orders not just phone
orders
 inspect filled copies of internal sales orders to see if credit approval was obtained
 observe despatch clerk counting and checking goods on transfer from warehouse to despatch
 reperform a bank reconciliation
7

DETECTION RISK AND SUBSTANTIVE PROCEDURES

 match them to details on supporting documentation (i.e. sales orders, delivery notes etc)
 reperform pricing and confirm validity of discounts given
 reperform casts, extensions and discounts and vat calculations
 trace to entry in the sales journal
 reperform postings to debtors ledger
 inspect documentation for signatures to indicate that control procedures have taken place.

Internal controls for CREDIT SALES transactions based on the control activities :
Segregation of duties - including the division of duties and the authorisation of various transactions. If no segregation of
duties is possible then management supervision of critical functions MUST be used. Internal control measures for credit
control function and initiating credit sales. Appropriate approvals for manual override of credit limits.
Physical controls – regular stock-takes must be carried out and any deviations from the theoretical inventory records must
be followed up
Information processing controls – programmed controls over pricing, calculations, product codes and description and
customer account codes. Programme code is password protected and all programme changes are reviewed and approved
by senior staff.
Operating reviews – management continually monitors and studies the internal control measures which have been laid
down to ensure that they are applied in the appropriate manner so if errors or weakness occur they can be corrected.
Management reviews are continually carried out (i.e. comparing actual performance with key performance indicators)
Reporting – printouts of GL balances etc as well as exception reports available at least monthly, and the reconciliation to be
verified and signed by a senior staff member (i.e. department head). Reports must include comparisons of actual current
financial year results to budgets and forecasts and prior periods, with explanations for variances and differences.
8
Substantive procedures for the audit of debtors

 assertion – rights by inspection of :

(the company
controls or holds  prior year workpapers
the rights to  minutes of director’s meetings
debtors)
 loan agreements
 bank confirmations
 enquiry of management to determine if accounts receivable have been factored, ceded or
encumbered
 assertion –  using debtors circularisation where independent confirmation is sought from the debtor (with
existence (debtors permission of management)
included in the
balance actually Debtor takes control of all the debtor’s statements immediately after they have been printed and :
exist i.e. they are not
fictitious) by : o tests to the debtor’s ledger and debtors schedule / age analysis to ensure that a statement exists for
each debtor and that a debtor exists for each statement
o selects a sample of statements for circularisation
Can either use :
o positive confirmation request – debtor confirms with the auditor whether the balance on the
statement is correct or not

o negative confirmation request – debtor confirms with auditor only if the balance on the statement
is not correct (not best choice cos positive circulation provides better evidence – no response to
negative circularisation may just mean that it went to fictitious debtor, the balance is incorrect but in the
favour of the debtor and doesn’t want to draw attention to it or that the balance is correct.
Auditor then encloses sticker / letter requesting that the debtor confirm directly with the auditor and self
addressed envelope. Auditor supervises posting of ALL debtor’s statements and stamps all the
envelopes to direct post office to return “addressee unknown” envelopes to the auditor’s address. Also
checks all P.O. Box addresses to confirm they are not fictitious (e.g. by checking in telephone
directories or confirming address with them personally)

Auditor monitors all replies to the circularisation, following up on disagreements (by following up by
reference to relevant source documentation, enquiry of debtors concerned or enquiry of the client’s
attorneys) and addressee unknowns and no replies (by re-circularising the missing debtors or checking
to see if they have paid the account after year end) so as to collect evidence relating to the existence
(and also slightly for valuation)

Errors identified through the circulation MUST then be projected over the entire population of debtors to
establish the extend of possible misstatement of the overall debtors balance.

 the matching of amounts owed at year end (debtor’s) payments to payments from debtors received
after year end (subsequent receipt testing). Principle is that if the debtor has paid an amount after
year-end then the existence of the debtor at year-end is confirmed, provided amount is due to year-end
balance and not for sales after year-end. Sample of debtors on the year-end debtors list is selected and
payments received from the selected debtors are identified and then traced to the debtor’s remittances
to identify which invoices the payment is in respect of. Invoices and delivery notes are then inspected to
confirm that they are dated prior to year-end and they were included at year-end in the sales journal and
debtor’s ledger.

 cut-off – establishes if the debtors existed as a debtor at year-end. Cut-off test must be performed
to ensure that they last invoices entered in the sales journal for the year were actually made prior to the
year-end (completeness)

 assertion –
valuation and
 gross amount – debtor’s control in GL is reviewed for unusual entries (e.g. credit journals at year-
allocation of gross
amount (debtors end) which are followed up. The total on the list of individual debtors must be matched to the debtor’s
control account in the GL and TB and amounts included on the list of debtor’s balances should be
included in the
traced to the individual debtor’s accounts in the debtor’s ledger.
financials at
appropriate
amounts) If comparison of the debtors list (as per the debtors ledger) to the balance in the debtors; control
account reveals that there are reconciling items then must :
9
o cast
o test the reconciliation logic
o follow up on reconciling items of the reconciliation.
The debtors list should be reviewed for credit balances and these should be followed up and reversed if
necessary.

If there were any problems in the debtor’s circularisation then these must be followed up if there is
evidence of valuation problems (e.g. debtor claims he has been charged twice)

Debtor’s list and control account must be cast

If debtor is in foreign currency, must :

o obtain amount of the sale in foreign currency by reference to the invoice

o obtain the exchange rates at transaction date and at the end of the financial year-end date and
multiply the amount by each of the two rates
o if there is a difference, confirm by inspection of the debtors account that the balance on the account
has been calculated using the financial year-end rate (i.e. the currency fluctuation has been accounted
for ..
 bad debts allowance – auditor should enquire what management’s method and procedures are to
estimate bad debts. The authorisation procedure must be established and evaluated (e.g. is it
authorised by credit controller or the financial director? Should be some one independent of credit
control). 
Must assess if the basis of calculating the allowance is reasonable and consistent with prior year and if
any changes in credit policy have been taken into account and all calculations must be reperformed.

Aging of debtors must be reperformed by selecting a small sample of debtors and tracing the amounts
owed back to the source document s (e.g. sales invoices and receipts) to determine if they have been
allocated over the correct time period.

Debtor’s correspondence & legal files must be inspected to identify disputed and handed over debtors

All long outstanding debtors and material debtors outside their credit terms must be identified and
discussed with credit management.

Analytical reviews should be reperformed :

o comparison of allowance (percentage) to prior year
o comparison of bad debts written off during the year against the prior year
o comparison of age analysis to prior year – i.e. is debt getting older?

o calculation of ratios

o investigation of changes year-on-year e.g. days outstanding debtors

Must enquire from management of any matters that might affect the allowance e.g. relaxing company’s
credit terms during the year, deterioration in the trading conditions of the business sector of the
company’s major customers

Actual bad debt write-offs during the year should be compared to the prior year allowance to obtain an
indication of the company’s ability to set reasonable estimates

All reports given to management about debtors should be reviewed (especially the reports for debtors
who have liquidity problems) and also lists of debtors written off

Potentially uncollectible debtors should be provided for on a debtor to debtor basis for those debtors
that are long outstanding or disputed debtors (i.e. an assessment of the recoverability of each debtor
must be undertaken). CANNOT simply create an allowance for bad debtors by taking a fixed
percentage of the gross debtors, unless strong historical evidence that the percentage chosen is an
accurate reflection.

Must consider all aspects of the debtor (some large entities only pay on 90 days but may be reliable
payers so not bad debt).
10

 assertion –
completeness
(all debtors  cut-off testing – select some of the invoices entered into the sales journal after year-end and
which should trace to supporting delivery notes etc to confirm that the goods were actually delivered after year
have been end. Select delivery notes prior to the year end cut-off delivery note number and inspect the
recorded sales journal to confirm that they were raised as sales prior to year end.
have been
recorded)
 Completeness of credit sales – if credit sales are not recorded then the debtor’s balance will
not be complete. Difficult to look for transactions that are not recorded, but should do following
procedures :

o sequence test despatch notes for missing notes (indicating goods picked and dispatched but
for which no debtor was raised)

o investigate any despatch notes which have not been matched to an invoice

o conduct extensive analytical review :

 analysis of gross profit percentage fluctuations
 comparison of sales / debtors to prior periods 

 analysis of recorded sales by characteristic for comparison to prior periods (e.g. by product,
branch, region, month, customer)

 comparison of sales ratios to prior periods (e.g. sales commission to sales)

o match purchases with sales where possible (so if company purchased 20 cameras and
invoiced out 15 then there should be 5 on hand

o obtain specific representation from management pertaining to completeness of sales

 assertion –
Auditor must inspect the financial statement disclosures and consider if :
presentation
and  they are consistent with evidence gathered on the audit
disclosure
 amounts, facts, details etc are accurate and agree with evidence gathered

 they are complete in terms of International Accounting Standards and the 4 th Schedule (i.e.
the balance is included in current assets – as part of accounts receivable – and that all
encumbrances on debtors have been disclosed

 classification of the information disclosed is appropriate

 working of the disclosures is clear and understandable (e.g. accounting policy and the
explanation of any encumbrances)

 assertion – general (all). Overall analytical review of debtors should be performed :

 comparison of debtors to prior year

 debtors in relation to credit sales compared to prior year

 number and amount of debtors by division, branch, product.

11

Substantive procedures for the audit of CREDIT SALES:

Activity Audit procedure
Authorisation of orders Inspect the signature of the credit manager on a number of orders that serve as
evidence that the orders were authorised (occurrence)

Source documents should be Examine a sample of delivery notes and sales invoices to ensure that all the
prenumbered numbers in the sales journal have been accounted for (completeness)
(delivery notes and credit invoices)

Compare the information contained Inspect the particulars on authorised orders and compare the particulars with the
in related orders, sales invoices delivery note and sales invoice (occurrence / completeness / accuracy / cut-
and delivery notes off / classification)

Information is transferred from the Agree the particulars of the sales invoice with the information in the sales journal
sales invoice to the sales journal to ensure that it is has been correctly recorded (occurrence / accuracy / cut-off
/ classification)

Posting to the general and Make certain that postings from the sales journal to the general ledger and the
accounts receivable ledgers accounts receivable ledger correctly carried out (presentation and disclosure)

SUBSTANTIVE PROCEDURES to which evidence can be obtained to the effect that CREDIT SALES have been
completely accounted for in accounting records and financial statements :

occurrence draw samples of credit sales invoices and compare each with the
corresponding order and delivery note in respect of name of client,
description and quantity of goods dispatched)

occurrence inspect the orders selected for approval by a responsible person

completeness select documented inventory issues in a case where reliable, continuous
(perpetual) inventory records have been kept and follow them up by
examining the corresponding delivery notes and sales invoices
completeness / accuracy / cut-off / trace sales invoices that have been checked to the credit sales journal
classification and confirm that the particulars agree and the transaction was correctly
allocated
completeness / accuracy / cut-off / recalculate the totals of the sales records for the selected periods to
classification make certain that the postings are accurate
accuracy / cut-off /classification check the posting of total sales to credit side of the sales account and
individual sales transactions to the debtor side of the accounts
receivable account
completeness / accuracy / cut-off / perform cut-off tests on sales invoices and delivery notes to ensure that
classification the transactions were accounted for in the correct accounting period
completeness calculate the gross profit percentage and compare with prior periods /
industry averages / budgets)
all assertions reconcile the list of accounts receivable with the accounts receivable
control account and confirm the correctness of the reconciling items
presentation and disclosure / Compare the amount of the turnover in the financial statements with the
completeness total of the trial balance and the general ledger
Accuracy Inspect the accuracy of turnover related adjustments in the general
ledger, for example discount, sales returns and Value Added Tax (VAT
Presentation and disclosure Inspect the accuracy of the disclosure of turnover in the financial
statements
12
Audit procedures that must be investigated for an audit of accounts receivable :
 ledger balances :  calculation of balances of the accounts receivable control account in the GL and the
individual accounts receivables in the accounts receivables ledger
 list of accounts receivables drawn up from the accounts receivable ledger
 accounts receivable age analysis drawn up

 documentation :  accounts receivable monthly statements issued at the end of the month
 reconciliations – general ledger, accounts  reconciliation of the accounts receivable accounts in the accounts receivable ledger and the
receivable ledger, list of accounts receivables accounts receivable statement at month-end
and statements issued :  reconciliation of the total per list of accounts receivables and the balance per accounts
receivable control account
 investigate differences between the list of accounts receivables and the control account by
means of adjustments

 cut-off procedures :  application of correct cut-off procedures on credit sales, receipts from accounts receivable,
returns, stock records etc
 accounting for information according to  bad debts written off according to age analysis and other relevant information
the established accounting policy :  provision for bad debts in accordance with management policy
 disclosure :  disclosure of accounts receivable in the Statement of Financial Position as part of the
current assets

Substantive procedures for the audit of the ACCOUNTS RECEIVABLE :

completeness / check the opening balances of the accounts receivable ledger accounts by comparing them
valuation with the closing balances of the preceding period
completeness / check the totals of the list of accounts receivable and make certain that the total of the list
valuation corresponds with the balance of the control account
completeness / compare the list of accounts receivables with the ledger balances after the balances of the
valuation accounts receivable accounts have been checked in the accounts receivables ledger
completeness / compare the balances according to the list of accounts receivables with the balances according
valuation / existence to the accounts receivable statements and make certain that there is a statement of account for
each accounts receivable
valuation / existence / follow up account receivables settlements of outstanding balances after year-end to the cash
rights receipts journal (cash book) to make certain that outstanding debts were collected by year-end
completeness / examine the composition of those balances that were not settled after year-end to determine
existence / rights whether they consisted mainly of recent invoices and credit notes
validation / existence / examine all accounts receivables with credit balances and obtain acceptable reasons from
obligations management
existence / valuation examine credit notes for a period after year-end with a view to the writing back of possible
fictitious transactions and the application of correct year-end cut-off procedures
completeness / examine the cut-off procedures with regard to sales and accounts receivable to make certain
valuation that only relevant transactions have been included
valuation / existence / carry out an accounts receivable circularisation and then evaluate the results and follow up on
rights all differences / queries
valuation examine the age analysis of all accounts receivables and discuss the adequacy of the provision
made for bad debts with management
valuation examine the attorney’s file for correspondence in regard to accounts receivable collections,
reminders and demands and other sources of information as well as the official notices of
insolvencies
valuation examine bad debts that were written off and discuss deviations from the policy on credit and
authorisation from management
completeness / calculate the relevant accounts receivable ratios and discuss material deviation with
valuation management
completeness / obtain an accounts receivable certificate from management stating that accounting for the
valuation / existence / debtors has been completed, correctly valued and does exist
rights / disclosure
disclosure examine the proper disclosure of accounts receivable in the financials - accounts receivable
less the provision of doubtful debts should be disclosed as a current asset
13
CASH SALES
Key aspects of accounting systems where cash registers are used for recording CASH SALES :
 each sales clerk has a cash register where all sales transactions have to be accounting for
 at end of the day sale clerk counts the money in the cash register and deducts the float from the total
 chief casher collects the money at the end of the day by unlocking the cash register
 sales indicted on the cash register roll are recorded in the cash sales register
 money is counted by the chief cashier and is recorded with the signature of the sales clerk next the amount that is
handed over
 chief cashier resets the cash register mechanism to zero
 when cash register rolls are used then it is printed and signed by both the chief casher and the cashier and then filed
 all the cash that has been received is banked the following day

INTERNAL CONTROL FOR A CASH SALE

Internal control Tests of control

Computerised invoices have to be numbered sequentially Test check the numerical sequence of the invoices using
CAAT’s

Should be adequate segregation of duties between the Observe that the person responsible for issuing the
person who issues the invoices and the person who invoices doesn’t receive the cash as well
receives the payment

No goods can be handed over to customers by sales staff Observe whether goods are only handed to a person if he
unless they have seen a copy of an invoices stamped shows a cash sale invoice stamped ‘paid’
‘paid’
No goods can leave the premises with out a valid copy of Observe if security agrees the items leaving the premises
an invoice stamped ‘paid’ with the cash sales invoices and checks that the invoices
has a ‘paid’ stamp

Summary of all the invoices must be reconciled daily with Compare reconciliation of the summary of cash receipts
the cash receipts. This reconciliation must be checked by with the actual cash received and confirm it has been
senior staff and any deviations should be followed up signed by authorised senior person as evidence that it has
been checked

Recording in the cash receipts journal should be checked Inspect the signature of the independent person on the
by independent person and compared with the daily cash receipts journal that serves as evidence that the
summary of invoices summary of the daily sales has been compared with the
entry in the cash receipts journal

Internal controls for CASH SALES

Risks of handing cash mean that reliable internal controls for cash sales and other cash receipts must be set up.
Internal controls for cash register used in handing of cash sales :
 register must display the amount of cash sales on a screen visible to the client and must print out an invoice showing
the sales that can be checked by the customer (information processing control)
 register must show a cumulative cash register reading which can be checked against individual amounts and the total
sales should be checked and a printout made (information processing control)
 only the accountant should have a key to the cash registers to gain access to the cash register reading (physical
control)
 after cash reading is taken at end of day the accountant must reset the mechanism to zero so the total day’s sales can
be compared to the cash on hand (physical control)
 accountant must make certain that cash registers are locked after the reading has been taken to prevent unauthorised
persons from gaining access to the cash registers (physical control)
 each cashier is responsible for one specific cash register and should NOT be permitted to work on someone else’s
register (segregation of duties)
 float for each cash register and cashiers and accountant should sign for the receipt and return of the float (segregation
of duties)
 cash register’s drawers should be lockable and be locked and unlocked by the accountant daily in presents of cashier
(operating reviews / segregation of duties).
14
SUBSTANTIVE PROCEDURES for the audit of CASH SALES where cash registers are used :

 test check the tally rolls of the cash register readings against the entries in the  completeness, occurrence
cash sales register and measurement
 test check the cashing of entries in the cash sales register  measurement
 test check the total of the cash sales as recorded in the cash sales register  completeness and
against the corresponding entry in the cash receipts journal and on the bank deposit measurement
slip
 test check total sales in the cash receipts journal against the deposits shown in  completeness, occurrence
the bank statements and measurement
Scrutinise the bank reconciliation for outstanding deposits at year-end. Follow these  Cut-off, completeness
outstanding deposits through to bank statements subsequent to year-end. Obtain
 explanations for deposits not cleared
 scrutinise the cash sales register for cash shortfalls and surpluses and discuss  measurement
material amounts with management
 test check postings to the appropriate sales accounts in the GL  measurement
 compare the monthly cash sales with those of prev months and prev periods and  completeness, occurrence
ask management for an explanation of any material fluctuations and measurement
 Compare the totals of the cash count performed at year-end to the tally roll totals  Accuracy
on year end, taking the cash float of each cash register into account
 calculate the GP % on sales and compare it with prev periods and ask  completeness, occurrence
management to explain any material deviations and measurement
 Trace the the balance for cash sales per the general ledger to the trial balance,  Completeness, accuracy
and to the amount included in the statement of comprehensive income for the
year.
15
STUDY TOPIC 6

EXPENDITURE

Nature of expenditure transactions

Normally :
 purchases of goods and services (credit and cash purchases)
 payments for accounts payable (creditors) and cash expenditure (disbursements) including cheque payments, EFT’s
and petty cash
Audit objectives for expenditure transactions differ for expense balances and expense transactions cos additional assertions
have to be substantiated for expenditure balances.

Risk associated with petty cash :

 cash payments for things that are not for company use (misappropriation)
 cash stolen or lost (if not in safe)
 petty cash vouchers can be lost or unavailable
 inappropriate or unnecessary stock can be bought (e.g. wrong size etc)

Details of information system gathered by :

 inspection of flowcharts of the system
 observation of the system in action
 inquiry of staff and the completion of internal control questionnaires
 discussions with prior year audit staff, management and outsiders (e.g. software suppliers)
 discussions with internal audit staff and review of internal audit workpapers
 tracing information through the information system.

Control activities
Policies and procedures that are implemented to ensure management’s objectives are carried out – e.g. :
 authorisation of transactions
 segregation of duties
 physical control over assets
 comparison and reconciliation
 access controls
 custody controls over blank / unused documents
 good document design
 sound general and application controls in IT systems

Jackson & Stent pgs 11/2 & 11/3

Accounting system and internal controls So company only receives goods that are validly ordered
Acquisitions and payment cycle deal with :
 ordering and receiving goods from suppliers and
 payment of amounts owing for goods ordered and received Payments are authorised, accurate and timeous
(very important that sound control procedures in place for outflow of funds to prevent misappropriation of company asset
- cash)
16
Documents used in the cycle :

requisitions (normally from stores department and can be  re-order levels or re-order quantities – normally in
determined by either : computerised perpetual inventory system
 production schedules that indicate when specific
inventory item is needed
 by particular request (written) from another department

order forms signed by chief buyer

suppliers delivery note cross referenced to the buyer’s order form and signed on
deliver of the goods
goods received note records actual goods received and cross-referenced to
supplier’s delivery note
purchase invoice from supplier
credit note for returned goods that were sent with returned goods
voucher
creditor’s statements

cheque requisitions by creditors for payment of supplier

remittance advice sent to supplier indicating invoices being paid
receipt
17
Actions and activities from purchases come from 3 functional areas :
· ordering function approved orders are place with suppliers. Ordering function has to obtain the correct type and
quantity of goods at the best price and desired quality.
· receipt of goods function
receiving goods from suppliers and acknowledging receipt of them. Only goods supplied on
valid orders can be accepted and all purchase orders have to be sent to receiving bay and filed
in numerical order. When delivery is made this purchase order must be checked against the
supplier’s delivery note and goods should be counted and any damaged or tampered with boxes
should be returned. Any items that weren’t ordered or that are being rejected must be clearly
marked on the supplier’s delivery note and should be signed by both the supplier’s staff and the
receiving clerk. Sequenced goods received note must be made out and sent with goods to the
receiving bay (in totally different area) where it is added to stores. Most problems occur in the
receiving function due to collusions between supplier’s drivers and receiving staff (so collusion
is one of the major limitations of internal controls!)
· purchases and account payable recording Ø recording of acquisitions and creditors – raises the expense or asset and the corresponding
function : liability in the accounting records. Before being entered must check the supplier’s invoice to the
purchase order, supplier delivery note and goods received voucher (especially the signatures of
control personnel). Should also check the prices quoted on purchase order and also the
accuracy of the discounts and vat etc
Ø payment preparation – all supporting documentation should have been matched and is not
reconciled to the creditor’s statement and creditor’s account in the company’s creditor’s ledger
and then a cheque requisition can be prepared
Ø payment – MUST be separate from payment preparation and signatory should carefully
check the supporting documentation before signing the cheque. Supporting documentation
should be marked (e.g. stamped) to prevent it being used for another payment.
Cheque is then sent to supplier with the remittance advice and payment posted to cash
payments journal and then creditor’s ledger and creditor’s control account.

Activities and actions to be done regarding the accounts payable balances :

· handling the ledger balances : Ø accounts payable control account in the GL must be cast as well as the individual accounts
payable accounts in the accounts payable ledger
Ø list of individual accounts payable balances must be compiled from the accounts payable
ledger
· reconciliation of records and documents : Ø accounts payable reconciliation must be carried out and compiled by comparing the
individual accounts payable ledger balances according to the accounts payable ledger,
supplier’s monthly statement and the relevant purchases invoices
Ø individual accounts payable balances from the accounts payable ledger must be compared
with the list of accounts payable
Ø balance of the accounts payable control account and the total of the list of accounts payable
must be reconciled
· disclosure : Ø accounts payable must be disclosed as a current liability in the Statement of Financial
Position

Activities and actions to be done regarding purchases :

· handling the ledger balances : Ø totals must be calculated on the purchases account in the GL
Ø purchases balance must be compared with the balance in the TB
· disclosure : Ø purchases must be disclosed as part of the cost of sales in the Statement of Comprehensive
Income
18
Characteristics of good internal control :
 control environment – managements attitude and actions should promote awareness of controls generally, BUT very
important for managers who authorise payments. Managers must ALWAYS carefully check supporting documents
before authorising payments and should NEVER leave blank signed cheques if they not available to sign
 competent, trustworthy staff – cycle has many opportunities for misappropriation of physical assets (goods) and cash
and significant risk of loss
 access / custody controls – very important to have controls over access to blank order forms (no invalid orders)
physical assets (goods) and bank account
 source document design
 division of duties – such as :
 person ordering goods mustn’t have access to goods and specially not authorise payment as well
 person with access to goods shouldn’t be able to amend the records. Also division between person receiving the
goods and custody of the goods
 person who signs cheque payments shouldn’t requisition cheques or prepare supporting documents
 isolation of responsibility – so person accepting goods must not be person who keeps the goods and authority for
payment out of the bank must be clearly isolated and traceable
 comparison and reconciliation – such as :
 reconciling creditor’s statements to company recorder before payment
 matching orders to goods received to identify unfilled orders
 reconciling company records to bank statements
19
CREDIT PURCHASES

Internal controls that would ensure that purchases are made only from approved suppliers :
 management should negotiate prices and payment terms and then approve a list of suppers from which goods can be
purchased (if computerised in the Approved Supplier Masterfile)
 only senior management should be able to make additions or alternations to this file (must use password controls if
computerised)
 each approved supplier must be allocated a unique supplier number which must be used on the purchase orders
(without it the order must not be approved – if overridden then should be by authorised person with a password)
 exception reports should be printed of all unallocated supplier numbers, amendments and overrides and these should
be followed up and signed.

AUDIT OBJECTIVE for CREDIT PURCHASES

to obtain satisfaction that all credit purchases made during the period recorded  completeness
have been recorded
to obtain satisfaction that recorded credit purchases have been Properly  occurrence
properly authorised. To obtain satisfaction that recorded credit authorized /
purchases represent goods, services and assets actually received presents goods
during the period actually received
to obtain satisfaction that all credit purchases have been correctly Correctly allocated,  accuracy / cut-off
calculated, allocated and recorded in the correct accounts in the GL in calc, recorded in / classification
accordance with GAAP policies applied by the entity. GL

Internal controls over credit purchases

The authority to purchase should be vested only in certain isolation of responsibility
specified employees or a
purchasing department
Only competent and trustworthy personnel should be competent and trustworthy personnel
appointed to the purchasing
department
Orders should be pre-numbered and control should be source document design
exercised so that all orders are
duly accounted for
A stationery register should be maintained by an custody
independent person to exercise control
control over the issue of unused order books and goods
received books
Segregation of duties should exists between personnel segregation of
responsible for: duties
Ordering of goods.
 Inspection and storage of goods received
 Ordering of goods.
 Inspection and storage of goods received.
 Checking of invoices against orders, delivery notes
and goods received notes
A record of goods received should be maintained and pre- source document design,
numbered goods received comparison and reconciliation
notes must be completed when goods are received
Invoices should be checked against appropriate delivery comparison and reconciliation, isolation of responsibility
notes, goods received notes
and orders, and must be stamped and initialled as having
been checked by the
responsible person before the transaction is entered in the
purchases journal.

Proper record must be kept of invoices in dispute and of comparison and reconciliation
goods returned to suppliers
. Management should set the tone to promote control control environment
awareness in order to create a
good control environment
20
Formulation of tests of controls to evaluate the internal controls governing CREDIT PURCHASES :
Internal control Test of control
Access control only granted to authorised staff to process Enquire and inspect documentation of delegated authority
purchase orders and menu levels control the authorisation for over-rides.
limits for individuals Inspect orders and confirm that they are within the
delegated authority limits
Gate keeper or receipts department receives the goods, Observe if the gatekeeper inspects the goods that have
inspects them and issues a goods received note been delivered and issues a GRN
Computer automatically pre-numbers all purchase orders Enquire and inspect the printout and other documentation
issued for later matching to goods received note and for proof of follow up of undelivered orders
supplier invoice – unmatched orders are reflected on a
printout
Accuracy of analyses and postings from the subsidiary Inspect the subsidiary books for the signature of the
books must be checked by an independent senior person responsible person who checked the accuracy of the
analyses and postings

Actions / activities investigating validity / occurrence of credit purchases

& applicable substantive procedures :
Actions / Activities Audit procedures
Inspect if there are orders for the selected credit purchase
Issue of an order for the purchase of goods transactions by comparing the orders with the appropriate
invoices and goods received notes
Authorisation of the transaction by the purchases manager Inspect the order to see if it bears the signature of the
(by signature on the order) purchases manager as evidence that the transaction has
been authorised
Inspect the credit purchases invoices to make certain that:
Receipt of credit purchases invoices showing following :  date falls within the current year
 date of execution of the credit purchase  supplier’s name is on the list of approved suppliers
 name of the supplier  name of the customer appears on the credit purchases
 invoice addressed to the customer invoice
 description of the goods, quantity, unit price & total due  goods purchased are goods that the enterprise uses
 signature of the person who checked the invoice and  signature of the person who checked the accuracy of the
compared it to the order and goods received note invoice appears on the invoice
Issue of a goods received note when goods are received Compare the information on the invoice with the
by the receiving department information on the order and goods received note.
21
Substantive procedures for auditing the completeness of credit purchases transactions :
Assertion Completeness of recording

Inspect the date on the credit purchases invoice and goods received note to determine if
All transactions are they have been recorded at the correct date.
recorded at the time of
execution

All transactions are

recorded in the  determine the number of the last goods received note at the cut-off date and compare
accounting records with information and date of the purchase invoice
 inspect the accounting records to make certain that the transaction has been accounted
for in the correct period
 inspect the goods received notes to ensure that they are prenumbered sequentially
 examine the file for outstanding goods received notes which have not yet been linked to
an invoice within a reasonable period of time
 examine the file with the outstanding goods received notes where inventory has been
received but cannot be compared with the invoices and so can’t be accounted for in the
GL
 compare the information on the goods received note with the information on the invoices
and compare this to the purchases journal
 compare the inventory purchases on the goods receive notes with the information
recorded in the inventory records
 inspect the monthly account payable reconciliation to ensure that all purchases of goods
transactions have been fully accounted for
22

Electronic Funds Transfer (EFT)

EFT payments consist of 4 steps :

1 Masterfile amendments
To transfer funds the account details of the recipients must be transferred to and stored by the bank – normally stored in a
masterfile so any amendments to the file must be :
 valid – no fictitious creditors
 accurate – bank account details shouldn’t have any errors
 complete – all new creditors added and all the required details (no omissions)

2 Preparation of the EFT payments

Controls should ensure that payments to be made are :
 valid – signatory should only authorise payment after scrutiny of supporting documentation
 accurate – computations should be tested before authorising payment
 complete – number of EFT payments is equal to the number of creditors that are being paid

3 Effecting the payment

Controls that relate to the validity, accuracy and completeness of the transfer are :
 number of computers from where the transfer can be effected should be restricted
 two passwords from 2 different managers should be required to effect a transfer
 bank must “identify” the computer before accepting transfer (e.g. call back facility)
 fully range of password controls should be implemented and should be automatic lockout after 3 unsuccessful attempts
to log in
 security violations should be logged and followed up
 functions available to employees should be restricted in terms of “least privilege” principle by user ID, passwords and
profiles
 transfers can be limited to a specific day for security
 data transferred can be encrypted
 bank should acknowledge receipt of information and may transmit it back to the client for final confirmation before
actually making transfers to creditors.

4 After the payment

Controls to ensure that the transfers made are valid, accurate and complete :
 system should supply an audit trail of all EFT payments made – e.g. bank will send a statement of all EFT’s made either
in hardcopy or on screen
 this audit trail must be reviewed by senior management and tied back to client held documentation
 all bank accounts must be regularly reconciled in a timely manner by someone independent of the EFT function.

 Substantive procedures
Used to gather evidence about specific transactions and in this cycle is normally verification of the creditor’s balances and
so main assertion to be confirmed here is completeness.
Normally liabilities are understated and so auditor will have to determine the systems ability to reduce the risk of
misstatement and responding by performing tests of controls and substantive tests. Also risk that there are transactions that
haven’t been recorded and so the balance is understated and the auditor has to perform specific procedures to identify
unrecorded liabilities.
As well as testing the creditor’s balance substantively auditor must also select a sample of the transactions processed on
the system (e.g. purchases and payments) on which to perform substantive tests. Auditor is seeking evidence of assertions
of occurrence, accuracy, cut-off and classification (so has a valid, authorised and genuine purchase or payment actually
taken place and has it been recorded at the correct amount, allocated to the proper period and posted to the correct account
in GL.

Example of substantive audit procedures (by assertion) that auditor can conduct on a purchase transaction :
 occurrence (valid transaction has occurred and it pertains to entity) :
 inspect supporting documentation to confirm that all documents are made out to the entity, are signed by the
designated person and all goods are used by the company
 inspect the cash payments / paid cheques / bank statements to confirm that the goods were appropriately paid for,
payment was authorised, correct payee and correct amount
 accuracy (amount of the transaction has been recorded correctly) :
 confirm the mathematical accuracy of the invoice by recalculating all extensions (quantity x price), casts and
discounts
 confirm prices and trade discounts on the invoice by inspecting the order or purchase contract
23
 recalculate vat and inspect docs to confirm that discounts were taken into account prior to the calculation of vat
 cut-off (purchase has been recorded in the correct accounting period) :
 inspect dates on supplier delivery notes, goods received notes and invoice to confirm goods were received during
accounting period under audit. Confirm date that purchase was recorded in purchases journal
 classification (purchase is recorded in proper account) :
 inspect purchase order to determine expense or asset account to which the purchase should be allocated and trace
the posting from the purchase journal to the account in the GL
 inspect the purchase journal and invoice and confirm vat has been correctly allocated and posted
 establish description of goods purchased and confirm classification of the purchase is appropriate (e.g. asset not
written off to expense account)
 inspect supplier’s account in creditor’s ledger to confirm purchase was correctly posted from purchase journal
 completeness (all purchases that should have been recorded have been recorded) :
 assertion doesn’t apply to audit of individual purchases

Dual purpose tests

These are combination of tests of controls and substantive tests and can be performed as follows :
 inspecting supporting documentation will confirm presence of :
 requisition from stores that is signed by authorised official for goods of a type used by the entity
 official company order form sighed by authorised buyer and is cross referenced to the requisition form that agrees to
description of goods requisitioned and is made out to a supplier on the list of authorised suppliers
 copy of supplier’s delivery note signed by authorised official in the company’s receiving department and agrees to
the description of goods that were ordered and is cross-referenced to the official order number
 official goods received note that is cross-referenced to the order and the suppliers delivery note, agrees to the
supplier’s name and description of goods that were ordered and is signed by the person who checked the quantity
and quality of goods
 supplier’s invoice with signature of clerk to show that an arithmetical accuracy check has been carried out, pricing
has been checked against the order and that the invoice was reconciled with the supporting documentation
 suppliers statement and reconciliation that is cross referenced and agrees in amount to the cheque requisition and
is signed by the clerk
 cheque requisition which is cross referenced to the creditors support documentation and bears the number of the
cheque used for payment and signed by the senior creditor’s clerk and the cheque signatories
 reperformance will determine if :  inspect the returned paid cheque is :
 casts and extensions (arithmetical accuracy) have been checked  made to the correct creditor
 prices are correct and  for the correct amount
 reconciliations have been correctly performed  appropriately crossed and dated
 inspect that :  signed by authorised signatories
 all external documents are addressed to the company being audited  stamped by the bank
 supporting documents have been cancelled (stamped paid and signed)
 documentation bears a date falling within the year under audit and that the dates on documents appear reasonable
in relation to each other.

Must also perform specific tests on the year-end creditors balances well as comprehensive analytical procedures on the
totals produced by the cycle (e.g. purchases, stationery etc)

Use of audit software for substantive procedures

CAATs used for creditors is not as effective as using if for asset accounts etc as with liability accounts auditor is concerned
with what is NOT in the accounts, but can still be used :
 creditor’s masterfile can be cast to obtain total amount owing and a detailed list of creditors and their balances can be
printed. Aging of creditors can be cast and cross-cast to the total
 masterfile can be scanned for errors (e.g. debit balances or blank fields such as missing account numbers)
 masterfile for the current year-end can be compared to the prior year masterfile to identify significantly reduced balances
and creditors who no longer appear
 software can be used to extract samples (e.g. amounts over a certain amount and nil balances)
 software can be used to extract lists of creditors that can be identified by particular field or codes
24
TRADE CREDITORS
Internal controls to ensure effective control over electronic transfers and payments of TRADE CREDITORS

 The number of computers from which the transfers or payments can be effected should be restricted.
 Two passwords from two different senior employees should be required to effect a transfer or payment.
 The bank must identify the terminal (PC) before accepting the transfer or payment (e.g. call back facility).
 Automatic account lockout after three unsuccessful attempts to access EFT applications.
 Security violations should be logged and followed up.
 A full range of password/identification controls must be implemented.
 Only authorised persons should be allowed to effect EFT payments and payments to trade payables and they should be
identified by way of user ID, passwords and profiles.
 Password and user ID should allow only authorised persons to effect changes to the approved suppliers’ master file.
 The financial accountant should authorise the payment of trade payables after scrutiny of supporting documentation.
 All documents must be stamped “paid” as evidence of payment.
 Monthly reconciliations of accounts payable amounts to supplier’s statements must be performed and remittance advices
should be prepared and attached to supporting documentation.
 The total of the accounts payable ledger listing (age analysis) should be reconciled to the general ledger accounts
payable control account.
 An exception report of unallocated payments should be reviewed by a senior official and resubmitted.
 Management should monitor the internal controls for EFT payments and payments to trade payables on a regular basis to
determine whether they are being applied.

Substantive procedures on the TRADE CREDITORS balance :

obligation  inspect the supporting documentation to confirm that they are made out in the name of the
(creditors represent company for purchase of goods used by the company.
obligation pertaining Inspection will take place when creditor’s reconciliations are audited at year-end evaluation
to the company) procedure and when any tests of transactions are conducted

existence Auditor must :

(creditors included  record the number of the last goods received voucher for the year (so that is the cut-off
in the balance number)
actually exist and  select from the purchase journal material purchases entered during the last two weeks of
are not fictitious) the year and trace to the relevance goods received voucher and supplier delivery note (via
the invoice)
 inspect these documents to confirm that the goods received number is lower then the cut-off
number and that the dates are prior to year-end date

valuation Carrying value of the creditors is the total amount of creditors and accruals so must :
(creditors included  agree the list of individual creditor’s balances to the balance on the creditor’s control
in the financial account
statements are at  agree a sample of individual creditor’s balances on the list of the creditors account in the
appropriate creditors ledger
amounts  agree the total of the accrual and creditors control accounts in the GL to the trail balance
 reperform casts of the creditors control account and creditors list
 identify any debit balances on the creditors list, establish the reason with the purchases
manager and consider if the balances should be transferred to debtors
 select a sample of creditors (including the company’s major suppliers) from the creditors list
and obtain the year-end creditors reconciliations performed by the creditors clerks.
Reperform the casts and agree balances on the reconciliation to the creditor’s statement
and creditors listing. Test the logic of the reconciliation by inspecting the supporting
documentation and by inquiry and confirmation confirm the validity of reconciling items
 obtain a list of accruals from the client and cast the list and agree the total on the list to the
account in the GL, trial balance and the Statement of Financial Position (included in
creditors)
 agree amounts recorded on the accrued list of invoices, statements and reperform any
calculations
completeness Normally entity will try to understate the liability rather then overstate them so auditor not
(all creditors and worried about what is NOT in the account that should be there and so completeness tests
accruals which will focus on identifying unrecorded liabilities :
should have been  compare the list of creditors at current year-end to the previous year-end and identify
recorded have been creditors on the previous list who don’t appear on the current list as well as creditors
recorded) balances that are significantly smaller in the current year-end, and then by enquiry and
25
inspection determine the reason for this
 inspect the creditor’s correspondence file for anything relating to unsettled disputes with
suppliers and discuss with management if have to make any adjustments to creditors
 inspect the list of goods received notes with unmatched invoices at year-end and confirm by
inspection a journal entry raising the corresponding creditors at year-end has been passed
and that the amounts are correctly computed (by reperformance)
 inspect the file of unmatched goods received notes and if any of them are lower then the
cut-off goods received note then ensure that the corresponding creditor was raised at year-
end (must be done soon after year-end)
presentation and  auditor must inspect the disclosures and consider if :
disclosure of trade  they are compete in terms of International Accounting Standards and the 4 th schedule (e.g.
creditors balance is included in current liabilities as part of accounts payable)
 disclosures are consistent with evidence gathered on the audit
 amounts facts, details etc are accurate and agree with the evidence gathered
 classification of the information disclosed is appropriate
 wording of the disclosures is clear and understandable

ACCOUNTS PAYABLE (TRADE CREDITORS):

Substantive procedure Assertion Audit objective
Compare the opening balances of the suppliers control To obtain satisfaction that accounts payable
account and individual supplier accounts with the Completeness / balances have been completely accounted for
corresponding closing balances of the previous year valuation at an appropriate carrying value
Compare total list of individual suppliers balances with To obtain satisfaction that the suppliers
Completeness /
the total of the control account in the GL balances have been completely accounted for
valuation
at an appropriate carrying value
Inspect the financial statements and ensure that To obtain satisfaction that the accounts
suppliers have been correct disclosed as current Presentation payable have been correctly disclosed and
liabilities in terms of GAAP and the Companies Act and disclosure classified in the financials.
26
Substantive procedures to audit the settlement of accounts payable (trade creditors)

Select a random sample of entries in the cash payments journal (cash book) and compare: Accuracy
name, amount, date,
on the paid cheque and other relevant
documentation for example orders, delivery notes, goods received notes, invoices and the trade
payable’s statement
Compare the amounts of the discounts received as shown in the CPJ (cash book) with those shown on Accuracy
the trade creditors’ statements and relevant receipts
Test check the calculations of discount as shown on the supplier statements and determine if they Accuracy
agree with the discount terms negotiated with the supplier.

Compare the following information on the cheque requisition with the information on the supporting Accuracy
documentation for accuracy:
 The beneficiary.
 The amount payable.
 The nature of the payment (for example creditor).
Inspect the calculation on the cheque requisition and supporting documents (orders, delivery notes, Accuracy
goods received notes, invoices and the trade payable’s statement) for accuracy
Inspect that the relevant documentation relating to each recorded payment has been cancelled by the Occurrence
cheque signatory with a “paid” stamp
Inspect that there is sufficient authority for the payment, namely the signature of an authorised person Occurrence
or two signatures of authorised cheque signatories on the “paid
cheque
Inspect that the amount in the cash payments journal (cash book) is correctly allocated to the trade Accuracy,
creditors column classification
Examine the accuracy of the postings to the relevant trade creditors accounts in the trade creditors Accuracy,
ledger, and in total to the trade creditors’ control account in the general completeness,
ledger cut-off
Ascertain the last cheque number drawn at the year-end and examine that no later cheques have been Cut-off
recorded as current period transactions. Trace the payments to
subsequent bank statements to ascertain that they have been paid within a reasonable period after
year-end
27
STUDY TOPIC 7
INVENTORY
Inventory cycle called conversation cycle, warehousing cycle and is the custody and safekeeping of inventory in any form
(e.g. raw materials, finished goods, consumables etc) and also recording of cost when the production / manufacturing
process occurs.
Inventory is major component of cost of sales, gross and net profit and raw materials so will be influential to the financials.
NB to have strong control environment for stock and physical access controls.
Acquisitions cycle “puts in” inventory and the revenue cycle “takes out” inventory so control in inventory cycle relies on good
control within these two supporting cycles.
Physical controls are required to prevent theft and damage, however the cost / benefit scenario is applicable to internal
controls and entity has to find cost effective manner of protecting the inventory that isn’t over budget.
As inventory is so critical to the fair presentation of the financials, anyone wanting to manipulate the profits and assets can
do so simply by overstating inventory on hand at year-end.
Inventory is very diverse – can be easy or hard to identify, easy or difficult to locate, have permanent value or be something
that is easily technological obsolete or something perishable like fresh fruit and can be in different stages of development
like raw materials, work in progress or finished goods.

Documents used in the inventory cycle :

 goods received note – must be signed by stores clerk when taking into stock items that were delivered by the supplier
 materials issue note / materials requisition – authorises the removal of items from stores
 manufacturing or production schedules – used to notify the production / manufacturing department what is going to
be produced
 job cards – tracks the stages of production for a specific job so as costs are accumulated (e.g. raw materials, labour
hours etc) they are recorded on the job card and can later be used to calculate the total cost of production
 production report – used to report results of production, output, wastage and identifiable stages or completion of
production
 transfer to finished goods note – transfers manufactured goods from the production department into the finished
goods store
 picking slip and delivery notes – used to select goods ordered from the stores and assist in controlling the movement
of the goods once they have been sold
 inventory sheet – used during stock count. Contains description of each item, location in stores and quantity of items
counted
 inventory tag – small numbered tag attached to different types of inventory before the count. Consists of two identical
blocks which show the inventory number and description and space to enter the total number of items – when first
counting team has a total of units they enter the number of items for that item in one block and then tear off that part of
the tag and give it to the count controller.
Second count team will then do the same with the other piece of the tag and the count controller will then match the two
parts of tag together and if there are any discrepancies that item will be recounted. Results in very accurate inventory
count.
 inventory adjustment form – sequenced document that is used to record adjustments that must correct the perpetual
inventory records when there are differences between the actual inventory and theoretical inventory.
28
Risks in the inventory cycle :
 inventory is lost or stolen due to inadequate :
 physical controls
 control over the transfer of inventory (e.g. unauthorised issues from stores)
 isolation of responsibility (e.g. unable to establish who is accountable for inventory at a particular stage)
 division of duties (e.g. storeman records and is custodian of the inventory so can conceal shortages)
 inventory deteriorates in value due to :
 inadequate physical controls (e.g. it gets damaged)]
 its nature (perishable foodstuffs, chemicals)
 delays and inefficiencies in production due to type, quantity or quality :
 incorrect raw materials are supplied to production
 non-availability of raw materials
 poor quality of raw materials
 unauthorised productions taking place (e.g. managers or staff doing private jobs with company materials)
 inadequate recording costs of production

Control procedures in the inventory cycle :

 transfers :
 no movement of inventory should take place without being recorded
 if transfer of inventory between departments then both deliverer and receiver must check and sign document
 transfer documents must be filed numerically
 documents should be regularly reviewed for authorising signature
 documents must be sequenced and missing documents investigated
 damage, loss and theft :
 physical controls should be implemented over all stores and production areas (limited and restricted entry,
controlled entry i.e. swipe cards, secure buildings and clean, dry neat environment with surveillance i.e. cameras in
production, receiving and dispatch areas)
 frequent comparison and reconciliation of :
o physical inventory and theoretical inventory
o actual production and manufacturing or production schedules
o actual production to budgets
 all material variances in reconciliations should be investigated
 regular supervisory and surprise management checks on production activity to identify unauthorised use of
production resources
 division of duties between custody of inventory and maintaining, recording and adjusting the perpetual inventory
records
29

Internal controls over inventory

Inventories are stolen  Limited access to warehouse, eg one entrance.

 Surveillance cameras at warehouse entrance.
 Security guards.
 High value items stored at a higher security location, eg upper level of
warehouse.
 Continuous inventory counts.
 Segregation of duties between warehouse staff and security guards
Financial losses due to fire in the  Fire prevention, eg sprinklers.
inventory warehouse  Insurance against fire.
 Training op employees on fire prevention
Stock is issued without it being  Segregation of duties between sales personnel and picking personnel at
invoiced warehouse.
 Security guard at the gate must sign off on goods leaving the premises by
comparing delivery note with sales invoice.
 Supervision of warehouse staff.
 Regular reconciliations by management between stock issued and sales for
the period.

Recorded inventory quantities do not  Continuous inventory counts.

agree with inventory quantities on  Regular reconciliations by management between recorded inventory and
hand physical inventory on hand.
 Segregation of duties between record keeping and warehouse staff.

Financial losses due to damaged  Regular inspection by management for deterioration in quality of
goods returned by customers inventory/obsolete inventory.
 Goods should be safely stored in the warehouse. High risk items should be
stored separately

.
.Financial assertions for the inventory and production cycle :
Auditor’s main concern is that the asset (inventory) is fairly presented in the financials.
Assertions applying to the inventory account balances are :
 rights – company holds or controls the rights to all inventory reflected in the financials (any encumbrances must be
disclosed)
 existence – all inventory actually exists at the financial statement date (so not overstated fictitiously)
 completeness – all inventory that should have been recorded has been recorded
 valuation and allocation – inventory is reflected in the financials at an appropriate amount (carrying value), so
appropriate adjustments have been made and the inventory is presented at the lower of cost or net realisable value
 presentation and disclosure – all matters are complete in terms of the 4th schedule and International Reporting
Standards and have been correctly classified and accurately presented and disclosed in an understandable way.

Auditor must have knowledge of the client’s business objectives, inventory management processes and business risks to
assess the effect of business risk and risk of significant misstatement during the audit.
30
Audit risks and audit objectives for a computerised inventory system where
stock records are updated with all purchases and sales :
Audit risks relating to stock Audit objectives – to obtain satisfaction that :
Stock received is not entered in to the inventory masterfile all stock is entered into the inventory masterfile
(completeness)

Stock received is entered into the inventory masterfile at all stock received is entered into the inventory masterfile at
the incorrect cost price the correct price (accuracy)

Quantity of stock received is entered incorrectly into the all sales made during the period have been recorded in
inventory masterfile the system (completeness)

Stock received is misappropriated before it can be entered all sales made during the period have been recorded in
into the inventory masterfile the inventory masterfile correctly (occurrence)

When sale is made, inventory goods are not updated All returns are correctly recorded in the system and
immediately updated in the inventory masterfile (classification)

Returns of stock are not updated in the inventory All the stock in the inventory masterfile represents stock
masterfile actually bought by the company (rights)

All sales recorded in the system represent sales made to

bona fide customers of the company (occurrence)

Fraud in the inventory cycle

Many different types of fraud – directors can perpetrate :

 fraudulent financial reporting such as :
existence include fictitious inventory so profit and current assets will
increase and related ratios will improve
valuation understate the write-downs for so profit and current assets will
obsolescence, damage etc increase
existence and valuation exclude inventory and / or overstate profit and current assets will decrease
inventory write-downs and company will look less valuable.
Will also reduce tax
 misappropriation of assets – theft of goods.
Thief will have to steal the goods, but also hide the theft, so lack of physical controls will make it easier to steal the goods
and lack of division of duties between record keeping for inventory and custody of inventory is easiest way to hide the
theft.

Actions / activities that form part of the accounting system for inventory :
 storekeeper takes possession of trading inventory by signing for it and ensures that the physical items in his possession
correspond to the particulars on the supporting documentation – purchase invoice, delivery note and goods received
note
 recording of the trading inventory received in the store records, either :
 perpetual inventory records – so number of items and the cost price of all inventory purchased and sold is recorded
in the inventory records (so number of items and their price available at any time). Must compare physical inventory
against the perpetual records regularly to ensure control is working and any discrepancies must be investigated by
management and corrective action taken.
 if no perpetual inventory then have to do a physical stock count – management task to find out what inventory is
actually on hand.
 inventory at year-end must be physical counted at year-end if done manually and if perpetual inventory system then
should still do physical count so that there is a true comparison for year-end.
 control of trading inventory on hand and issuing goods – storekeeper responsible for inventory under his control and
should be adequate measures like physical security and segregation of duties to ensure the safely of the inventory.
Stock should also be packed and arranged in an orderly manner so that items can be traced and identified
immediately
 keeping of the inventory control account in the GL – value of all inventory purchases and sales are accounted for at
cost price and figures showing the value of inventory on hand can be kept up to date
 ratio analyses for trading inventory – management can use the gross profit percentage to calculate the theoretical
inventory figure and then compare it to the actual inventory figure in the continuous inventory records or with the
physical stock count. Can also be compared with previous results or with results of similar enterprises.
Can use gross profit percentage to calculate inventory as an overall control to determine if the inventory figure is
reasonable.
31
Assertion – rights (the company holds or controls the rights to the inventory)
 enquire if any inventory is held on consignment for other parties
 establish if inventory is encumbered (i.e. held for security) by discussion with management, inspection of bank
confirmations, review of directors minutes, review of correspondence / contracts with suppliers & credit providers
 when performing the pricing procedures for the valuation assertion, inspect the invoices to ensure that they are made
out to the client (also done when testing purchase transactions)

Assertion – valuation and allocation (inventory is included in the financial statements at appropriate amounts). Value is
worked out by multiplying the qualities by the cost price of the item and then the allowance for inventory obsolescence must
be established
 arithmetic accuracy - auditor must :
 compare the quantities of items from the stocktake to the client’s priced inventory sheets (to confirm the client hasn’t
altered the quantities)
 test the arithmetic accuracy of the inventory sheets by reperforming all the values (extensions) and casting the total
inventory value (extension column)
 review inventory sheets for any negative inventory item values
 compare the total inventory value per the inventory sheets to the GL and trial balance
 pricing inventory – auditor must :
 use a sample that were test counted in the inventory count and trace back to relevant suppliers invoices to establish
if the correct purchase prices have been used. Then check that the cost formula used by the company is correct :
o FIFO – so work out what the item cost and then find how many are left and work backwards from last invoice to
see how many items are left and what they would be valued at
o weighted average calculation – calculate the cost and divide by the amount of items bought and then average
all the purchases to find the value for stock
 enquire from the costing clerk and inspection of invoices from transporters if the relevant carriage costs are included
in the unit cost calculations.
 pricing manufactured goods – enquire of appropriate personnel and inspect documentation to understand the costing
method used and determine if it is consistent with prior years and is appropriate for the business
 if standard costing system is used then determine if it is appropriate by discussion with management and inspection
of budgets and historical records and evaluate the treatment of variances at year-end to confirm that the value of
inventory has not been inappropriately increased
 by inspecting the costing schedules and supporting documentation :
o agree description and prices of materials used
o agree labour costs to payroll records
o confirm that the allocation of overheads includes only fixed and variable production overheads based on normal
capacity and on a reasonable systematic basis
 confirm that costs that don’t qualify aren’t included such as :
o admin overheads
o selling expenses
o abnormal amounts of wasted material, labour or other production costs
 confirm that under and over recoveries of production costs are correctly treated through the Statement of
Comprehensive Income
 reperform all casts and calculations
 lower of cost / net realisable value – using a sample verify the selling price of inventory items by reference to sales
lists and the most recent sales invoice for that item. Compare sales prices on invoices for a small sample of sales
made in the post Statement of Financial Position period to the cost prices of the inventory sheets to give evidence of
the most up to date realisable value
 inventory obsolescence allowance – discuss with management :
o how they determine their obsolescence allowance and evaluate the process for reasonableness and
consistency with prior years (e.g. do they used a fixed percentage each year (only acceptable if strong historical
evidence to support the percentage) or is a detailed analysis carried out
o what is the procedure for the approval of the final allowance – who approves it?
o did anything specific occur during the year – i.e. flood damaging inventory items
o any specific inventory items that may be obsolete and how is this recognised when calculating the allowance for
obsolescence
 perform analytical procedures to give a general overview as to the reasonableness of the allowance by compression
of current year figures and / or ratios to prior years, such as :
o the allowance itself
o the allowance as a percentage of total inventory
o inventory turnover ratio
o days inventory on hand
 reperform the aging of inventory by tracing it back to source documents
 compare allowances raised in prior years to actual write-offs in subsequent years to judge the accuracy of
managements allowances
32
 review working papers from year-end tests to ensure that inventory items that are damaged, obsolete or slow
moving have been included in the allowance
 reperform any calculations of inventory obsolescence allowances and discuss the reasonableness of the allowance
in terms of evidence gathered with management
Assertion – completeness and existence (all inventory which should have been recorded has been recorded and the
stock included in the Statement of Financial Position actually exists and is not fictitious)
Normally primary evidence is gathered when attending the inventory count, and additional evidence can be provided by
analytical review. Cut-off tests performed when auditing the revenue and receipts cycle and acquisitions and payments
cycle will provide evidence that all the inventory that was purchased has been included and that inventory that has been
sold is not included

General – all assertions

Auditor must :
 perform an overall analytical review of inventory by comparing current year figures and ratios with prior years (e.g. total
inventory, total inventory by category or location or source and inventory as a percentage of current assets and total
assets)
 references to inventory (especially allowance for obsolescence) must be included in the management representation
letter.

Assertions pertaining to presentation and disclosure (ISA 500 – audit evidence)

Auditor must inspect financials disclosures and consider if :
 they are compete in terms of International Accounting Standards and the 4th schedule
 they are consistent with evidence gathered on the audit
 amounts, facts, details etc are accurate and agree with the evidence gathered
 any classification of the information disclosed is appropriate (e.g. finished goods, work in progress)
 wording of the disclosures is clear and understandable (e.g. for reversal of impairment)

Substantive procedures on inventory

 Enquire of management as to whether any inventory is held on consignment for other parties.
 Establish whether inventory is in anyway encumbered, by discussions with management, inspection of bank
confirmations, review of director’s minutes and review of any correspondence with suppliers and credit providers.
 Agree the prices on the final inventory sheets with those shown on the relevant invoices towards the close of the
financial year.
 Test check the calculation of the value of a number of representative inventory items as they appear on the inventory
sheets.
 Examine the basis used for the calculation of the inventory (FIFO) and ensure that it is consistently applied in relation to
previous years.
 Inspect that obsolete, slow-moving and damaged inventory is valued at the lower of cost or net realisable value.
 Compare the value of the main categories of inventory with the previous year, investigate and obtain explanations for
material differences.
 Calculate the gross profit percentage and inventory turnover rate and compare them with the previous years’ budgets,
industrial averages’, and so forth.
 Obtain explanations and examine material deviations.
 Obtain a certificate from management regarding the value of inventory, basis of valuation, main categories of inventory,
encumbrance of inventory, and so forth.
 Compare the value of inventory with the value of inventory in the financial statements according to the inventory count,
taking into consideration possible alterations.
 Perform analytical review procedures by comparing the current year’s figures and ratios to corresponding figures of
prior years.
 Inspect financial statement disclosures and consider whether: they are complete and consistent with the terms
of IFRS statements and the 4th schedule
33
Auditing the value of inventory

Arithmetic accuracy 1. Agree the prices on the final inventory sheets with those
shown on the relevant invoices towards the close of the
financial year.
2. Test check the calculation of the value of a number of
representative inventory items as they appear on the
inventory sheets.

Pricing of inventory 3. Examine the basis used for the calculation of the
inventory (FIFO) and ensure that it is consistently applied in
relation to previous years.
4. Inspect that obsolete, slow-moving and damaged
inventory is valued at the lower of cost or net realisable
value.
5. Test a representative sample of items for the valuation of
inventory at the lower of cost price or net realisable value.
6. Compare the value of inventory according to the inventory
count with the value of inventory in the financial statements,
taking into consideration possible alterations.

Inventory obsolescence allowance. 7. Discuss with management the process used to determine
their obsolescence allowance
and evaluate the process for reasonableness and
consistency with prior years and the
approval of the final allowance.

General 8. Compare the value of the main categories of inventory

with the previous year, investigate and obtain explanations
for material differences.
9. Calculate the gross profit percentage and inventory
turnover rate and compare them with
the previous years’ budgets, industrial averages, etc.
10. Perform analytical procedures to give a general overview
as to the reasonableness of the obsolescence allowance by
comparison of current years figures and/or ratios to prior
years. Obtain explanations and examine material deviations.
11. Obtain a certificate from management regarding the
value of inventory, basis of valuation, main categories of
inventory, encumbrance of inventory, etc.
34
Inventory counts
Cycle counts
Must have frequent comparisons and reconciliations of actual assets to theoretical assets so that discrepancies can be
timeously identified and investigated, and then preventive measures put in place to prevent the problem re-occurring.
Companies with large stock performs cycle counts (if operate perpetual inventory system of inventory).
Procedures of cycle count :
 time of the count must be planned at the start of the year
 items to be counted must be identified – can be done different ways e.g. random samples, items susceptible to theft,
high value items, section of warehouse or entire stock divided into sections so that all the items are counted at regular
intervals during the year
 physical inventory is then counted using acceptable method of counting and sound count controls
 physical count number then compared to theoretical number on the perpetual inventory records and discrepancies
entered into a sequenced inventory adjustment form
 all discrepancies must be investigated by internal auditor and inventory controller
 adjustments to records must be done by someone independent of custody, receiving and issue of stock and only after
warehouse manager has reviewed the adjustment forms and authorised them by signing
 perpetual inventory records must be reviewed periodically by senior warehouse personnel and any adjustments must be
traced back to authorised inventory adjustment forms
 overall analysis of discrepancies over a period must be conducted to identify trends (e.g. if frequent discrepancies in
one section of warehouse only, then need to investigate that).

Year-end inventory count

If company doesn’t operate perpetual inventory system then only way of getting a closing inventory figure is to do a physical
count and then price it. Very important that procedure of this count is impeccable as if mistakes are made then can have a
material effect on financials.
Procedure of year-end stock count :
 planning and preparation
 design of stationery
 written instructions
 performing the count under supervision to ensure that all items are counted at least twice, and that variances are
identified and recounted immediately.

Management responsible for complete, accurate and valid stock figures in the financials. Companies Act states that
companies must carry out at least one inventory count per year and that statements of the annual inventory count should be
updated and kept as part of the accounting records of the company.
35
Internal controls for trading inventories when the continuous (perpetual) inventory system is used :

 segregation of duties  between staff responsible for physical handling of

inventory and recording inventory
 inventory issues must be authorised by store manager
 inventory write-offs must be authorised by financial
manager
 physical controls  access to store restricted to storekeeper and people
under his control
 adequate physical security must be maintained and
one person must be responsible (e.g. store keeper)
 no goods to leave store without valid requisition
 financial records and stock take must be compared
regularly and shortfalls and deviations must be
investigated
 information processing controls  computerised monitoring of inventory levels against
sales demand levels which will indicate re-order levels
and economic order quantities
 pre-numbered inventory requisitions for stocked issued
must be captured onto the system and printed
 daily printout of all unfilled inventory requisitions and
these must be followed up regularly
 recording of any deviations traced during inventory
counts must be checked by independent person to
make sure that the information is correctly transferred
to the accounting records from the count sheets
 financial manager must continually monitor the
inventory write-off account to ensure that only
authorised write-downs are done
 inventory requisitions must be agreed with invoices to
ensure that all issues from stores have resulted in
actual sales transactions
 operating reviews  laid-down internal controls for inventory must be
continuously observed and studied by management to
ensure that they are being applied in the way that they
were designed
 errors and weaknesses should be analysed by
management and corrective action must be taken or
internal controls should be changed if necessary
 surprise visits and comparison of the inventory and
accounting records must be undertaken by
management and corrective action must be taken
where there are variances and weaknesses are
exposed
 reporting  printouts of the GL balances and other detailed reports
(such as exception reports) must be printed monthly
and distributed to various departments for
reconciliation
 this reconciliation must be verified and signed by the
department head
 reports should include comparisons of actual current
figures with budgets and forecasts and prior period
amounts with explanations for the differences
36
Tests of controls
Auditor’s will mainly focus on substantive testing for the inventory balance, but will carry out some tests of controls :
 observation of the inventory count
 inspection of the reconciliations and cycle count amendment forms for counts carried out during the year (to determine
the frequency and materiality of discrepancies and how they were resolved)
 inspection of stores controls to determine the effectives of :
 access control (custody and safekeeping)
 authorised documentation to record inventory movement
 stores layout to facilitate implementation of physical FIFO system
 inspection of records controlling inventory movement e.g. :
 inspecting sample of requisitions and materials issue notes for authorising signatures and cross referencing to job
cards
 inspecting sample of inventory movements per the perpetual inventory records to transfer to finished goods notes
 enquiry of production and warehousing as to what procedures they actually perform
 recomputation of calculations on production schedules, performance reports and other costing records

Tests of control that auditor will carry out to obtain satisfaction that there is adequate control over the stationery
used during an inventory count :
 observe is there is adequate control over unissued count sheets
 ensure all inventory sheets for the count have been pre-numbered
 inspect the schedule on which a summary of the count sheets have been made and observe if the person who received
the count sheets signed for them
 observe if the count sheets have been recorded as being returned on the summary schedule when the count sheets
are received back
 ensure that all count sheets have been signed by the counters
 observe if there is adequate control over the count sheets that have been returned to prevent unauthorised changes to
them
37
Substantive procedures
Performace of year-end procedures down into 2 phases ;
 attendance at the year-end inventory count – evidence of existence and also part of completeness and valuation)
 subsequent audit of the carrying value – evidence of valuation, rights to the inventory and the presentation and disclosure of
inventory.

Attendance at the year-end inventory count

Both test of controls and substantive procedure :
 when auditor gathers evidence as the effectiveness of the control procedures to establish the quantity of inventory actual held then is
testing controls
 also gathers substantive evidence about :
 existence of the quantity of inventory recorded by testing from records to the physical inventory
 condition of the inventory by inspecting and locking for damaged / obsolete items as well as evidence of slow moving inventory
 completeness of the inventory by testing from the physical inventory to records
 subsequent audit procedures will also be substantive in nature (i.e. after the inventory count)
 very important to record the last documents numbers for all documents used (e.g. delivery notes, goods received notes etc) for “cut-
off” testing. Also very important that the recorded movement of inventory matches the physical movement of inventory up to
Statement of Financial Position date
 list of goods received note numbers which have not been matched to supplier’s invoices at year-end must be drawn up and used to
test the completeness of creditors.

Audit procedure for attendance PRIOR to the inventory count auditor must :
 liaise with client about date and time of inventory count
 confirm all locations where the client holds inventory (by enquiry, reference to prior year work papers)
 perform administrative planning (e.g. which staff to attend which location)
 obtain and review copy of the written instructions given to the client’s count teams
 enquire as to whether the client has any inventory that should NOT be included in the count (e.g. consignment inventory or item that
have been invoiced but not yet collected or delivered)
 brief the audit staff about their responsibilities

Audit procedure for attendance DURING inventory count auditor must :

 observe the stock-take procedure to ensure that the client’s written instructions are being adhered to
 walk through the store and identify inventory which is obsolete or damaged and that appears to be slow moving (dusty or old
packaging). Auditor must record the inventory number and location and then trace this back to the inventory sheets to confirm that
these items are marked damaged / obsolete
 conduct test counts on the inventory in the warehouse in both directions to make sure all sections and categories are tested :
 from inventory sheets to physical inventory (existence)
 from physical inventory to inventory sheets (completeness)
 resolve discrepancies in test counts before conclusion of the count by recounting with the staff and confirming that amendments are
made to the inventory sheets where necessary
 test the numerical sequence of the inventory sheets before and after the count to ensure they are all accounted for
 confirm by enquiry of the inventory counters and inspection of the inventory sheets that inventory that wasn’t supposed to be included
is excluded

Audit procedure for attendance AT THE END of inventory count auditor must :
 inspect the inventory sheets to confirm that :
 lines have been drawn through blank spaces (so nothing can be added afterwards)
 alterations / corrections have been signed and
 inventory sheets have been signed by the counters that did each section
 create audit records in respect of the inventory count attendance by :
 taking copies of all inventory sheets (hardcopy or digital)
 recording observations of the client’s count procedures
 recording results of all test counts performed by the audit team
 recording any damaged / obsolete / slow moving inventory that was identified
 record cut-off numbers of all documentation used in the inventory and production cycle
 compile a list of goods received notes which have not been matched to supplier invoices.

The inventory count must provide sound evidence that the quantities and description of inventory on hand at Statement of Financial
Position date is accurate.
Client will then make any adjustments that are necessary to the perpetual inventory records and must calculate the value of the inventory
on hand.

Inventory turnover rate = cost of sales divided by average inventory

Period’s inventory on hand = average inventory divided by cost of sales x 365

Substantive procedures for inventory transactions consist mainly of auditing movement on the inventory records through purchases,
sales, returns and other adjustments.
38
Substantive procedures the auditor would carry out to ensure that trading inventory is shown at a reasonable value in the
financials (using continuous perpetual inventory system, FIFO and auditor was satisfied with the physical inventory count at year-end) :
 examine prior years working papers to determine if the valuation method (FIFO) is consistent with previous years
 recalculate additions and total inventory amounts using CAATs
 agree the balance in the continuous (perpetual) inventory masterfile and with the GL control account and the trial balance. Follow up
any reconciling items
 select a sample of purchases inventory items and perform the following tests :
 inspect most recent supplier invoices to determine that the correct cost price has been used for the valuation of inventory
 inspect sales invoices subsequent to year-end to ensure prices exceed inventory costs
 inspect the inventory list in respect of the sample items chosen and ensure that inventory has been accounted for at LOWER of
either the cost price or at the net realisable value (selling price)
 inspect if obsolete, slow-moving and damaged inventory has been valued at the LOWER of cost or net realisable value
 perform analytical review procedures :
 compare the value of the main categories of inventory with values for previous years and investigate any material differences
(obtain explanations from management)
 calculate the gross profit percentage and the inventory turnover rate and compare then with the budgets / forecasts, previous
years, industrial averages etc. Obtain explanations from management and investigate material deviations
 obtain a signed management representation letter indication the value of inventory, basis of valuation, main categories of inventory
and any encumbrance of inventory etc
39
STUDY TOPIC 8
HUMAN RESOURCES / PAYROLL

Documents used in the cycle :

 employment contracts / employee file  formularised terms and conditions of employment kept
in employee’s personnel file in personnel department
 payroll amendment form  used to detail and authorise changes that affect the
workforce e.g. new appointments, dismissals, promotions
or pay rate changes
 batch control sheets and batch register  identify batches of clock cards and controls their
movement between functions in the payroll cycle
 list of employees  all valid employees and their details provided by
personnel department
 deduction tables and returns  EMP docs as well as schedules for medical aid,
provident fund etc
 payroll / wage journal  spreadsheet listing employees, work section or cost
centre, overtime and normal hours worked, gross pay and
deductions and giving net pay
 pay packets, payslips, salary advices  notifies employees how the remuneration is made up
 unclaimed wage register  book / journal used to record details of employees who
haven’t collected pay packets
 wage / salary reconciliation  records the reconciliation of the week’s wages to the
previous weeks wages (or monthly for salaries)

Characteristics of good internal control – PAYROLL CYCLE

 control environment  must be very strict adherence to payroll controls or will

result in fraud
 competent, trustworthy staff  cos of cash and need for accuracy and deadlines in
payroll cycle
 division of duties  essential that it is strictly enforced and all functions
must be clearly divided (so person creating the supporting
documents mustn’t have any access to the cash, cheques
or bank account). Must be division between “doing” and
“checking” all duties of payroll – e.g. recording hours,
preparing the payroll and paying over the cash
 isolation of responsibility  cos large number of people involved in cycle and cos
of high risk of fraud employees must be fully aware of
where their responsibilities start and finish (so must be
able to prove that they carried out their function as
required) e.g. when transfer clock cards must sign for
number of cards they receive and hand over to pinpoint
the insertion of a fictitious employee. Ditto with cash
 access / custody controls  blank clock cards, salary account cheques, clocking
machine and the cash (before pay packets are done, pay
packets themselves and unclaimed wages)
 source document design  all principles of sound source document design apply
(so clock cards should be easy to calculate and record
normal and overtime hours, have space for employee
details and authorising signatures). Payrolls should be
designed to facilitate easy payouts and clear identification
of gross wages, total deductions and net pay and should
have space for the recipient to sign for receipt
 comparison and reconciliation  between current and previous weeks wages (including
number of employees and amounts paid)
 reconciliation of details on the payroll (prepared by
salaries department) and also records kept by the user
department
 reconciliation of people to personnel records and visa
versa (especially in large entities)
40

Differences and similarities of wages and salaries documentation and accounting procedures :
Wages Salaries
Documentation : Documentation :
 employee personnel file contains all communications  employee personnel file contains all communications
about employment. Employee allocated a staff number about employment. Employee allocated a staff number
for computerised payroll records for computerised payroll records
 clock cards record daily in and out hours in manual  salaries staff sign an attendance register for the number
system, while swipe cards are used in computerised of days they work during the month. Leave forms are
system filed
 employee payslip reflects the information from the  employee payslip reflects the information from the
payroll printout and is the employee’s record of payroll printout and is the employee’s record of
remuneration remuneration

Accounting treatment : Accounting treatment :

 clock cards are sent to wages department every week in  attendance registers are sent to salaries department at
a manual system, while in computerised system the end of the month
smart card reader updates the accounting system
automatically
 clock cards are used to calculate the number of hours  attendance register are used to calculate the number of
each employee has worked days the salaried staff worked in the month
 permanent records are used to determine the rate per  permanent records are used to determine the salary per
hour paid and also the authorised deductions for each month and also the authorised deductions for each
employee employee
 payroll is prepared for the total wages :  payroll is prepared for the total wages :
 gross wage calculated according to hours worked  gross wage calculated according to days present
 net wage obtained by deducting authorised  net wage obtained by deducting authorised
deductions deductions
 total of all net wages added up  total of all net wages added up
 cheque prepared for the total net amount according to  financial department prepares a salary cheque or EFT
the payroll and then cashed transfer for each employee for the net salary owing
 cash is placed in the wage envelopes by salary
department
 any cheque payments are recorded in the payments  any cheque payments are recorded in the payments
journal and allocated to wages journal and allocated to salaries
 wages are paid out to the employees during a wage  salary cheque either given to employee or the EFT is
pay-out transferred to their account

Internal controls for wages and salaries that make it possible to :

 obtain satisfaction that all staff appointments and resignations, changes to pay rates and total net wages payable are
authorised (occurrence / validity) :
 logical access controls ensure only authorised personnel can add new employees or make changes to the standing
data on the employee masterfiles (printouts must be made of all amendments to the masterfile)
 pay sheet for total net wages payable must be authorised by signature of manager of the salaries department
 obtain satisfaction that the accounting accuracy of all wage transactions have been checked and that the information is
substantiated by supporting documentation and records (measurement) :
 programmed limit and reasonableness checks of hours worked as well as input validation checks of employee name
and code numbers
 programmed calculations of weekly and monthly payrolls from hours worked and standing data for gross pay rates
and deductions and analysis of the cost allocations. Automatic production of payroll printouts and payslips for
employees
 exception reports printed of any employees duplicated or omitted from the payroll, hours worked in excess of the
norm and gross pay that exceeds the category of employee or missing data such as unallocated costs
 each employee must have a clock card with hours worked or a permanent record showing rate per hour
 senior manager must ensure there is a clock card for each employee and that only authorised rates have been used
to calculate wages
41

Internal controls over a wage payout

 Physical security must exist over cash for disbursement as wages.(access / custody control)
 The amount due to each employee should be recorded on a payslip, which should be handed to the employee
together with the sealed wage envelope. (access / custody control, source document design)
 Each worker should be properly identified before the particular wage is paid out,(official staff card). (access /
custody control)
 Disbursement should proceed in the presence of an authorised official, who supervises the proper distribution of
wage envelopes. (access / custody control, control environment)
 The disbursing clerk should mark off in the wage records all wages that are paid out. (isolation of responsibility)
 Employees should sign the wage record as evidence of having received their wages. (control environment,
comparison and reconciliation, isolation of responsibility)
 Wage envelopes not disbursed should be marked as unclaimed, and the disbursing clerk and an authorised official
should check the unclaimed wages to the wage record and should sign the wage record as evidence of having done
so. (comparison and reconciliation, isolation of responsibility)
 Management should set the tone to promote control awareness in order to create a good control environment.
(control environment)

Substantive procedures when attending the wage payout – auditor should arrive after the cheque for the week’s wages
has been drawn and the employee pay packets have been filled and then should :
 check the total number of pay packets against the week’s payroll printout
 count the money in a fee packets and agree the amounts with the payslips and the payroll printout
 assign members of the auditing staff to all pay points and instruct them to travel to each payout point with the client staff
distributing wages
 observe identification of employees and payments of the pay packets to them
 observe the recording of unclaimed wages on the payroll printouts, delivery of the packets to the cashier and the
recording of the details of such packets in the unclaimed wages register
 ascertain through enquiry if the unclaimed wages are for genuine employees who were unable to claim their wages
(could reveal wages drawn for fictitious employees)
 inspect the signature on the payroll printout of the persons responsible for paying out the wages (normally two)

Substantive procedures to audit wages

 By enquiry and observation confirm that there is appropriate segregation of duties between staff involved in
authorising changes in personnel records and rates of pay, preparation of the payroll and handling of the cash and
pay packets.
 Inspect a selection of payrolls and note the signatures on the payroll records of the person(s) responsible for
checking the accuracy and compilation thereof.
 Compare pay slips with clock cards in respect of names, hours worked, authorisation by the foreman and dates.
 Compare pay slips with personnel records for authorisation of rates and other deductions.
 Draw a sample of clock cards and trace these through to the personnel records (master file) and ascertain that the
relevant employee details agree.
 Recalculate the hours worked per clock card and trace details to the payroll.
 Confirm authorisation of payroll summary and wage transfer by the designated official.
 Reconcile the approved payroll summary to the electronic funds transfer.
 Follow the approved payroll summary and wage transfer through to the entry in the cash payment’s journal and
bank statement.
 Perform analytical procedures, for example:
o compare total wage expense with that of previous years
o review payroll summary for unusual amounts
 Confirm on a sample of payslips that the wage deductions are correctly deducted and correctly accounted for in the
accounting records.
42

Internal controls over unclaimed wages

 Unclaimed wage envelopes should be returned to the cashier or paymaster, who should record it in an unclaimed
wages register and safeguard it.(access / custody control)
 The cashier or paymaster should sign the payroll record to acknowledge receipt of the unclaimed wages identified.
(isolation of responsibility)
 The pay-packets may not be released to other parties, for example a family member, unless the employee has
given written permission. (access / custody control)
 Wages still unclaimed at the close of the following week should be deposited in the bank. (access / custody control)
 When unclaimed wages are subsequently paid, proper identification of the employee should be established.
Employees should sign the unclaimed wages record to acknowledge receipt of their wages. (access / custody
control)
 The unclaimed wages register should be scrutinised periodically by a senior independent person and long
outstanding unclaimed wages should be investigated and re-deposited. (comparison and reconciliation)

Substantive procedures to be performed to audit unclaimed wages.

 Observe whether unclaimed wages are properly recorded on the payroll and in the unclaimed wages register.
 Physically identify employees for whom wages were recorded as unclaimed.
 Investigate the authenticity of any employees whose names appear regularly in the unclaimed wages register.
 Confirm that unclaimed wages are re-banked within a reasonable time, by inspection of entries in the unclaimed
wages register, bank records and deposit slips.
 Confirm that employees sign the unclaimed wages register when they subsequently claim their wages.
 Select one month and reconcile the unclaimed wages as recorded in the payroll to the unclaimed wage register.

Weaknesses in the wages system

Segregation of duties The manager is responsible for appointing and dismissing

employees, as well as the maintenance of the employee
master file - there is not sufficient segregation of duties.

Access controls Unauthorised access to the factory can take place, as there
are two entrances, with access control only at the one
entrance.

Authorisation Employees clock in without supervision - employees can

easily clock in for colleagues who are not, in fact, present.

Accounting process  The factory foreman is the only one who enters the
information from the clock cards. Errors can occur and he
can easily manipulate the hours worked.
 The wage clerk just prints the required information. He does
not recalculate or do test checks and errors can occur.
 The paying clerk should not have the authority to pay
wages and no reconciliation of the wages is done.
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Tests of control for wages, salaries and wage disbursement :

Internal control measure Tests of control
Wages – authorisation of rate Scrutinise each employee’s personnel file and ensure that the rates of pay and any
changes changes have been authorised in writing and filed

Salaries – checking Inspect if the signature of the responsible person who checked the arithmetic
arithmetical accuracy of payroll accuracy is on the payroll

Wage payout – identification of Observe if all employees are properly identified when wages are disbursed either by
employees their staff cards or id numbers before their wages are handed over.

Salary transactions – Inspect evidence of checks on the reconciliation of hiring and termination for
occurrence / validity of salary monthly-paid staff against total number of employees on the payroll.
transactions Select sample of standing data changes and inspect the supporting documentation
in the employee’s staff files for evidence of authority of changes in pay etc.
Select several monthly payroll printouts and inspect signatures of person
responsible for checking accuracy & their authorisation for payment.

Assertions
Wages and salaries are written off in the period in which they incurred (not carried forward).
Highest risk is that the expense will be overstated cos of inclusion of fictitious payments so auditor must concentrate on
occurrence (i.e. did a valid non fictitious expense occur) but also concerned if expense was accurately recorded in the
correct time period (cut-off) in the proper accounts (classification).
Employees will complain if they are underpaid (so wage calculations normally correct) but not if they have been overpaid
extra (errors can be made with deductions). Completeness not normally risk but auditor should establish that entity is not
employing people illegally (e.g. illegal immigrants or paying illegally low wages) cos this could be reportable irregularity and
there might be contingent liabilities.
Any statutory deductions that have been made but not paid over at year-end are liabilities and so assertions must be
relevant to liabilities (and are audited as part of creditors).
44

Audit procedure – salaries and related accounts Audit procedure – wages and related accounts

Occurrence Occurrence
Auditor’s intention is to obtain evidence that salaries are paid If auditor decides to use the base week method then at
to genuine living people who work for the company so could planning stage must choose certain weeks where he attend
: payout as a surprise visit as follows :
 extract a sample of employees from the salaries register  arrive at client after pay packets have been prepared but
to establish the validity of the employees by : before they payout takes place
 inspecting the documents in the personnel file  take custody of all the pay packets and agree names,
(contract, identity details, tax forms etc) accounts and number to the payroll
 compare employee’s signature in the salaries  accompany the paymaster as he distribute the wages
register to the one in the staff file and
 enquire of senior personnel whom you trust (e.g.  correctly identify each employee
financial accountant) to vouch for the validity of any  enquire of the foremen as to the authenticity of the
staff whom auditor doesn’t know personally employees
 if still in doubt then perform a surprise visit to create  observe if unclaimed wages are properly recorded
positive identification on the payroll and in the unclaimed wages register
 discuss with personnel staff or by examination of (on next visit ask to see the employees who had
employment and dismissal documents to confirm unclaimed wages and request their identification)
that :  inspect the unclaimed wages register for the period
o staff are entered into and removed from salaries since the last attendance at a payout and :
register on the correct date  investigate the authenticity of any employees whose
o employment and dismissal documentation is names appear regularly
properly authorised by the designated staff  confirm that unclaimed wages are rebanked within a
 confirm with managers if employee is or was reasonable time
employed through the period  conduct tests on personnel record :
 insert copies of returns to outside entities for the  select a random sample of employees from the
inclusion of employees selected in the sample (e.g. payroll for the base week and inspect their
IRP5 returns will have the details of PAYE deducted personnel records (UIF, PAYE, contracts, medical
from all staff and can be matched to personnel and union details etc) to confirm existence of
records) employees
 if salaries paid by EFT then CAATs can be used to  use the same employees and examine the returns
scan the masterfile for errors that could indicate made to outside entities (e.g. SARS) to ensure that
fictitious employees such as : the employees in the sample are included in the
o duplicate or missing identity numbers return.
o missing or duplicated tax numbers  if salaries paid by EFT then CAATs can be used to scan
o duplicated bank account numbers the masterfile for errors that could indicate fictitious
o duplicated staff employee numbers employees such as :
 duplicate or missing identity numbers
 missing or duplicated tax numbers
 duplicated bank account numbers
 duplicated staff employee numbers
Auditor must be satisfied that the hours that have been
recorded on the clock cards have actually been worked
(occurrence). Using base week can use the following tests of
controls :
 observing the clocking function to determine if the
physical controls and supervision limit the opportunity of
fictitious or incorrect hours being recorded
 enquiry of management concerning the integrity of the
foreman
 inspect the foreman’s signature authorising the time on
clock cards
 reperformance of the calculation of hours on the clock
cards
 evaluation of whether hours could be added to an
employee after clock cards done (i.e. during payroll
preparation)
Difficult to establish if controls over the prevention of
fictitious hours being recorded operate effectively throughout
the year but if satisfied with hours recorded in the base week
then has basis for comparison and can investigate large
fluctuations or hours recorded in other weeks identified by
45
analytical review.

Accuracy, cut-off, classification Accuracy, cut-off, classification

Auditor can : For the weeks of the surprise payout attendance must
 inspect and confirm employee’s gross salary (in the inspect the payroll and supporting documents to confirm that
salaries register) to the authorised listing kept in the :
personnel section and visa versa  wage rates both normal and over time used are
 if salary changes have taken place then inspect the authorised and total hours have been correctly
latest increase authorisation list to confirm that the computed and split between normal and overtime hours
correct new salary is being used  all deductions are in accordance with the appropriate
 compare all deductions to the appropriate tables / tables and rules
agreement to ensure that the correct amounts are being  by recalculation confirm that :
used – discuss any discrepancies with personnel  extensions and casts on the payroll are correct
 recomputed the deduction calculations and test the  gross wages minus deductions equals net pay
arithmetical accuracy of the salaries register – casts and  postings from the payroll to the general ledger are to
cross-casts the proper accounts
 inspect the returned salary cheques for proper  confirm that the clearing accounts are cleared accurately
crossings, any suspicious endorsements and to confirm and timeously by inspecting the paid cheques or EFT
that the correct amounts as per the salary register were payments to relevant authorities
paid
 by reperformance verify that postings from the salaries
register to the relevant accounts in the GL are correct
(net salaries and all deductions)
 by inspecting the dates and details on copies of the
outside entity returns and paid cheques verify the
clearing accounts of any deductions and ensure
amounts were paid over to relevant authorities timeously
 inspect to confirm that the salaries and deductions paid
pertain to the period under audit.

Completeness
If there is suspicion that the amount paid for hours worked is
not being accounted for as wages then must :
 perform reverse employee identification – from physical
employee to personnel records and returns
 enquire of senior management in personnel about the
practice of employing illegal workers
 be alert to any unsupported payments of any kind
(especially cash)
 investigate the validity of “casual wages”

General / analytical procedures General / analytical procedures

Auditor should : Auditor should :
 compare salaries on a month to month basis in total and  on each subsequent visit the client and at year-end –
by cost centre, department or division and investigate perform some tests on the week to week reconciliations
any large fluctuations working from the base weeks and select :
 carry out ratio and trend analysis such as :  a few additions and resignations / dismissals and
 commission as a percentage of total sales trace them to personnel records
 salary expense as a percentage of total expenses  any changes in pay rates for particular grades of
 review payroll ledger accounts for unusual amounts or staff and inspect the payroll amendment form to
entries that need further investigation – e.g. lump sum confirm they have been correctly implemented (by
payments, 13th cheques etc reperformance of the calculation of the wage
payment)
 at year-end audit can perform analytical procedures by
comparing individual week to the base weeks e.g. :
 net wages week to week
 net wages section to section, week to week
 total wages for the year to prior year
 total wages in relation to other variable such as
production, total number of employees and
investigate any fluctuations
 trace balances on the wage and related accounts to the
trial balance
46

Assertions pertaining to presentation and disclosure Assertions pertaining to presentation and disclosure
Staff salaries are not a disclosable item, but there are some Wages are not a disclosable item so no procedures are
salary related disclosures, so auditor should inspect the necessary other then for related disclosure (e.g. post
financial statement disclosures and consider if : employment benefits)
 they are complete in terms of International Accounting
Standards and the 4th Schedule (e.g. director’s
emoluments and post employment benefits)
 they are consistent with the evidence gathered on the
audit
 amounts, facts details etc are accurate and agree with
the evidence gathered
 any classification of the information disclosed is
appropriate
the wording of the disclosures is clear and understandable

Use of audit software – substantive procedures

If computerised salaries and wages then auditor can use software to :
 scan the masterfiles for errors such as
 no amounts in “YTD” earnings field
 missing names, employee numbers etc
 negative earnings
 net wages greater then gross earnings
 stratify and summarise masterfiles by section, grade, branch and region for analytical review purposes
 extract complete list of employees employed or dismissed / resigned during the year and each can be tied back to the
supporting payroll adjustment form
 extract random list of employees for physical identification
 extract a sample of employees reflecting pay rates, grades etc to be verified against supporting documents

Substantive procedures to obtain satisfaction that the wage and salary balances have been correctly disclosed in
the financial statements :
 inspect the financials to check that the salaries and wages are shown as an expense in the Statement of
Comprehensive Income for the period under review.

Audit working papers for wages and salaries will normally consist of the summary of the accounting and internal control
systems, audit procedures to be followed and the working papers that will serve as evidence that the audit was correctly
carried out and in full.
47
STUDY TOPIC 9
INVESTING AND FINANCING
Tangible assets are held on a long term basis and are acquired to conduct a business and not normally for resale at a profit.
Used to generate income for entity in an indirect manner that can’t be measured in practice.

Finance and investment cycle deals with :

 raising of finance and repayment of finance
 obligations that arise out of finance raised – interest must be paid or dividends may be payable to providers of share
capital
 application of funds raised for the acquisition of assets
Finance = audit of capital employed section of the Statement of Financial Position
Investment = audit of non-current assets

Fraudulent financial reporting

Directors could try to manipulate provisions, impairments or fair values and might try to improve the financials by :

valuation creating unjustified reserves with a getting inflated property valuation to

corresponding increase in fixed manipulate “fair values”
assets
completeness omitting long term liabilities not recording a new loan or disguising
the inflow of cash as income or not
capitalising finance leases
valuation undervaluing long-term liabilities not amortising debentures
redeemable at a premium
valuation overstating plant and equipment, failing to write-down obsolete or
vehicles by understating depreciation impaired machinery
allowances and impairment
valuation overstating investments in listed or failing to write-down the cost of
private companies investments in private companies
where the fair value of the investment
has fallen below costs on the grounds
that there is no available valuation
valuation understating or omitting provision not providing for long-term
environmental damage that the
company has an obligation to rectify
valuation omitting or inadequately disclosing the company doesn’t mention a
contingent liabilities pending lawsuit in the notes which
may have grave consequences
existence and rights overstating property, plant and including the assets of a related party
equipment by including fictitious
assets or assets which are not owned
by the company

Misappropriation of assets
Might be unauthorised use of the company’s assets for personal use – e.g. using the vehicle over the weekends or securing
personal loan using company assets or directors making unauthorised long-term loans to themselves.
48
Audit objectives to be achieved when auditing the fixed asset balances and transactions :
Fixed asset balances Purchase and sale transactions of fixed assets
To obtain satisfaction that : To obtain satisfaction that :
 fixed assets balances at Statement of Financial Position date  recorded acquisitions and disposals of
include all investing transactions during the period (completeness) fixed assets include all such transactions
 recorded fixed assets exist and represent productive assets in use that occurred during the period
at Statement of Financial Position date (existence) (completeness / cut-off)
 fixed assets are stated at cost or revaluation at Statement of  recorded acquisitions and disposals of
Financial Position date (accuracy) fixed assets actually occurred during the
 fixed assets are stated at cost or revaluation less accumulated period, were properly authorised and
depreciation less any write-down for impairment so as to reduce none were duplicated (occurrence)
them to their carrying value at Statement of Financial Position date  acquisitions and disposals of fixed assets,
(valuation) proceeds from disposals and repairs and
 entity owns or has the rights to all the fixed assets at Statement of maintenance expenses have been
Financial Position date (rights and obligations) recognised and measured in accordance
 disclosures e.g. cost or revaluations, carrying values, depreciation with GAAP and consistently applied by
methods and useful lives of major classes of fixed assets are the entity (accuracy / classification)
appropriately disclosed (presentation and disclosure)

Assessing the risk of misstatement – use of conventional procedures :

 enquiry of management and others e.g. production staff about impairments, company’s lawyers about contingent
liabilities
 observation and inspection e.g. observing the manufacturing process, reviewing long-term loan agreements, budgets
etc and minutes of meetings
 analytical procedures e.g. comparing the client’s production performance with industry norms
 other procedures e.g. consulting the previous audit team, industry specialists, reviewing industry journals
 holding discussions among the audit team e.g. drawing on experienced members, calling for questions from new
members
Responding to the risk at financial statement level
Must use only experienced and technically strong audit staff to audit the financing and investment cycle account headings.
Responding to risk at assertion level
Auditor must decide on the nature, timing and extent of tests that will reduce audit risk to an acceptable level i.e. mix of tests
of controls and substantive tests (observation, reperformance, inspection etc), including :
 nature :
 as only few transactions normally auditor can limit tests of controls and perform detailed substantive tests on each
transaction and the account as a whole
 should verify the opening balance of the account, vouch transactions making up the movement on the account
(including adjusting journal entries) and then verify that the closing balance agrees with and is appropriately reflected in the
financials.
e.g. if company has raised a loan and repaid a loan then will audit by :
Opening balance - compare to prior year’s closing balance in working papers

New loan - vouch as transactions (occurrence, accuracy, cut-off, classification and completeness)

Repayment - vouch as a transaction (occurrence, accuracy, cut-off, classification and completeness)

Subsequent - e.g. if an amortisation of a debenture redeemable at a premium adjusting journal has been done
measurement then must vouch for the transaction (occurrence, accuracy, cut-off, classification and
adjustment completeness)

Closing balance - cast account and confirm that the appropriate presentation and disclosure has been achieved
 extent – normally few transactions so can be audited individually – if large entity then might have to do substantive
testing on samples based on the assessment of the internal controls
 timing – tests can be conducted at the interim or final stage. Sometimes external auditor may be consulted during the
year at the time of the transaction for advice and then some of the audit work may be done at that time
Engagement partner may decide that there are complexities and want to engage an expert as part of audit strategy
49
Auditing fair value measurement and disclosure
Normally fair value can be straightforward like when using share price listings, but in case of more complex fair values then
ISA 545 says auditor should :
 obtain understanding of entity’s process for determining fair value measurement and the relevant control activities that
will allow him to identify and assess the risk of material misstatement at assertion level
 evaluate if the fair value measurements and disclosures in the financials are in accordance with IAS’s
 if the intention of the directors is an important part of how the asset or liability is measured and disclosed then the
auditor must :
 consider management’s history of carrying out its stated intentions
 review written plans and other documentation (e.g. minutes, budgets etc) to clarify and confirm management’s
intentions
 consider the logic and reasonableness of management’s reasons for choosing a particular course of action
 consider management’s ability to carry out an intended course of action
 evaluate if the entity’s method of fair value measurement is applied consistently
 if the measurement of fair value involves the use of assumptions or forecasts (e.g. valuation of a private company) then
must evaluate if :
 the assumptions are reasonable
 an appropriate valuation model was used
 the underlying data was relevant and reliable
 perform audit procedures on data used for fair value measurement and disclosure to determine if it is accurate,
complete and relevant
 consider the effect which any subsequent events may have on fair values
 obtain written management representations pertaining to fair values used – e.g. the reasonableness of significant
assumptions
 if applicable discuss the fair values with those charged with governance (e.g. If there is significant use of fair values)

The extent of internal controls introduced for fixed assets depends on the value and number of the fixed assets owned by a
particular organisation.
Activities / actions normally associated with the purchase and continuous use of non-current / fixed assets :
 appropriate authorisation should be supplied by management for the purchase of non-current assets and the form of
financing that will be used (e.g. cash payment, loan, installment sales etc)
 quotations obtained from approved suppliers and decision made where to buy asset
 apply for financing if necessary
 register the asset in the owner’s name if the right of ownership is subject to legal registration requirements (e.g.
property)
 non-current asset is received and the particulars are agreed with the information on the supporting documentation
 purchase of the non-current asset is recording in the accounting records in accordance with the information on the
supporting documentation
 asset posted in the ledger according to the category of the asset (e.g. plant, vehicle)
 record the non-current asset in the appropriate heading in the non-current asset register
 ensure insurance is available to reduce the risk of damage and loss
 expenses for maintenance and repairs will be incurred to keep the non-current asset in good working order
 write-off depreciation for the non-current asset annually to provide for a decline in the value of the assets
 authorised persons should undertake regular physical inspection of the asset and compare it to the particulars in the
non-current asset register and the relevant ledger account
 sale or write-off of a non-current asset should be authorised by management and the appropriate entries must be made
in the accounting records and the non-current asset registers
 non-current assets are disclosed in the financial statements at cost price less accumulated depreciation after the
amounts and the particulars have been agreed with the non-current asset register and ledger accounts.
50
Nature and control of financing activities
Audit of financing activities includes auditing the borrowings, interest bearing borrowings (secured and unsecured) and
installment sale agreements as sources of financing. In a normal commercial enterprise the financing activities include
funding for business operations and capital investments.
Borrowings
Long-term borrowings normally incurred to finance non-current assets or operating capital – classified as obligations
incurred for periods of longer then a year. If repayable within a year then they are current liabilities
Portion of the long-term borrowings that is repayable within a year is shown as current liability in the operating liabilities of
the entity (“current portion of loan”)
Interest bearing borrowings either :
 secured loan – e.g. registration of mortgaged fixed property. Must have account of the amount of the loan, repayment
conditions (term, interest rate, payment due etc) and the security advanced for the loan
 unsecured loans – no security is provided for the repayment of the loan. Need to know the repayment conditions
(term, rate of interest, payments)
Specific condition applicable to the loan are set out in the loan agreement.
Accounting entries either :
Funds borrowed and paid into entity’s bank / funds borrowed and paid directly to 3rd party for value rendered
Dr Bank Dr Fixed assets / other value rendered
Cr Long-term Loan Cr Long-term Loan

Audit of Share capital issued and share premium of private companies

Opening balance – inspect prior year workpapers and prior year financials closing balance to confirm that the opening
balance agrees
Occurrence – inspect the Memorandum and Articles of Association and any relevant special resolutions :
 for any conditions that the issue has to comply with
 to establish the company has the necessary authorised (but unissued) share capital to make the issue
 to confirm the par value of the shares (if there is a par value)
Inspect the minutes of the meeting of shareholders of the year for confirmation of conditional or unconditional
authority granted to directors to make the issue
If any shares were issued to directors then confirm that the provisions of the Companies Act have been
complied with :
 confirm by inspecting minutes that specific authority was given for the issue
 or inspect the issue documentation and register of shareholders to confirm that the shares were issued in
proportion to existing holdings as were issued to other shareholders
 inspect the relevant underwriting contract
Inspect the register of shareholders and agree details to the share capital account in the GL noting that the
addition of new shareholders and changes to existing shareholders agree with the minutes
Inspect the notification from the Registrar to confirm that the issue was lodged within one month and that the
necessary fee was paid
Trace the receipt of cash to the deposit slip / bank statement or inspect for appropriate evidence of value
received by the company if the consideration received for shares was other then cash
Completeness – confirm with the directors that no other share issues have taken place during the year
Accuracy, cut-off, classification – reperform the calculations to verify that the consideration received for the share is in
accordance with the share price as authorised (accuracy) and the split between share capital and share premium
is correct (classification).
Inspect invoices and chq payments supporting amounts written off to share premium confirming they were :
 actually incurred
 genuine share issue expense
Confirm by inspection the dates on the supporting documentation that the issue took place during the accounting
period under audit (cut-off)
Cast the share capital, share premium or stated capital accounts.
Closing balance – trace the closing balance on the share capital and share premium or stated capital accounts to the
financial statements (from balances in the Statement of Changes in Equity)
Assertions pertaining to presentation and disclosure – auditor must inspect the disclosures in the financials and
consider if :
 they are complete in terms of ISA’s (i.e. number of shares authorised and issues, rights, preferences and
restrictions attached to that class of shares and details of shares issued to directors)
 consistent with evidence gained on the audit
 amounts, facts, dates etc are accurate and agree with evidence
 classification of the information disclosed is appropriate
 wording of the disclosure is clear
51
Audit of Reserves
Movements on reserve accounts are normally book entries and not transactions (i.e. journals to allocate profits or evaluate
assets). Emphasis when auditing reserves is if the necessary authority was obtained and that regulations were complied
with.
Opening balance – inspect prior year workpapers and prior year financials closing balance to confirm that the opening
balance agrees
Occurrence – inspect Articles of Association to confirm that movement on the reserve account complies with requirements
stipulated in the articles (e.g. non-distributable reserve must be created for re-valuations of fixed assets.)
Inspect minutes of director’s meetings for authority of directors to effect movement on reserve accounts
(e.g. transferring profits)
Confirm by inspection of the GL and journal that Companies Act requirements have been compiled with if
necessary
Refer to the ISA’s to confirm that the accounting treatment for any adjustments taken directly to equity are
appropriate
Accuracy, cut-off, classification – if the reserve arose out of the revaluation of fixed assets then :
 consider the qualifications, suitability and independence of the valuer
 inspect the report on the revaluation noting that it relates to the fixed asset that is
revalue according to the records and decide if the valuation appears reasonable
 if necessary consult experts on the reasonableness of the revaluation
If the reserve arose out of the profits on the sale of fixed property then inspect the
sale contract noting the selling price, authorised signatures, terms and conditions etc
Recomputed all figures and amounts involved ensuing that the amount transferred to
the reserve is correct
Confirm by inspection that the correct balances have been carried from the
Statement of Comprehensive Income to the Statement of Financial Position (e.g.
profits for the year)
Closing balance – trace the closing balance on the reserve accounts to the financial statements (from balances in the
Statement of Changes in Equity)
Assertions pertaining to presentation and disclosure - auditor must inspect the disclosures in the financials and
consider if :
 they are complete in terms of ISA’s
 consistent with evidence gained on the audit
 amounts, facts, dates etc are accurate and agree with evidence
 classification of the information disclosed is appropriate
 wording of the disclosure is clear
52
Audit of Debentures in a private company
Audit of debentures (regarded as loan capital) is a mix of procedures similar to those of share issues and long-term
liabilities. ISA 39 requires that debentures are held at amortised cost so auditor must bear this in mind when auditing a
debenture that is redeemable at a premium. Also required to use effective interest to correctly reflect the value of the
debenture at each reporting date and the finance cost associated with it.
Effective interest rate exactly discounts estimated future cash payments through the life of the financial instrument and can
include transaction costs. So true finance cost (interest plus premium) is calculated and spread over the life of the
debenture.

Must test the transaction / account heading for compliance with all relevant financial reporting standards while still using
conventional auditing procedures (enquiry, recalculation, inspection).
Opening balance – inspect prior year workpapers and prior year financials closing balance to confirm that the opening
balance agrees
Occurrence – inspect Memorandum and Articles of Association to whether :
 company is authorised to issue debentures
 issue isn’t contravening company’s borrowing powers in any way (e.g. authority requirements)
 inspect minutes of director’s meeting at which the decision to issue debentures was taken and note :
 to whom the issue was made
 number and amount of the debentures issued
 interest rate, date and manner of payment
 any particular characteristic of the debenture (e.g. repayable at premium, convertible to shares)
 director’s don’t need shareholder approval to issue debentures unless they want to issue debentures
convertible to shares to themselves
 inspect the cash receipts journal, deposit slip / bank statement for evidence of the receipt of the correct
amount
 inspect the register of debenture holders to confirm that the addition of new debentures holders and
adjustments to the holding of existing debenture holders have been made in accordance with the
authority granted for the issue

Accuracy, cut-off, classification : Initial recognition (on issue) :

 reperform the calculations and casts to confirm that the cash received from the issue
of debentures is in accordance with the debenture agreement (accuracy)
 trace the receipt of cash from the cash receipts journal to the GL to confirm that it
was posted to the debentures liability account (classification)
 inspect the date on all documentation to confirm that they fall within the accounting
period under audit (cut-off)
Subsequent measurement :
 recalculation the effective interest rate based on the terms of the debenture
agreement and compare to the effective interest rate used by the client in the
amortisation calculation
 inspect the journal entry raising the finance cost and increasing the debenture liability
account and agree the amounts to the amortisation calculation
Completeness – confirm by inquiry from the directors and scrutiny of the minutes that no other debenture issues have
taken place during the year
Closing balance – trace the closing balance on the debenture account (after the finance charge / amortisation adjustment)
to the trial balance
Assertions pertaining to presentation and disclosure - auditor must inspect the disclosures in the financials and
consider if :
 they are complete in terms of ISA’s (i.e. details of any security which has been granted to debenture
holders, bond over fixed property and dates and conditions of any redemptions or conversation options)
 consistent with evidence gained on the audit
 amounts, facts, dates etc are accurate and agree with evidence
 classification of the information disclosed is appropriate
 wording of the disclosure is clear
General – if necessary obtain 3rd party confirmation from the debenture holders (confirm the amount of debenture, interest
rates, redemption premium and conditions of redemption) for the assertions.
53
Audit of Long-term loans
Audit plan will be to audit substantively the opening balance, movement on the account including any adjusting journal
entries and the closing balance. Auditor is seeking evidence about the assertions relating to the balance on the long-term
liabilities account (obligation, existence, valuation, completeness as well as evidence to support the assertions applicable to
the presentation and disclosure of information about the account heading (accuracy, cut-off, classification, completeness
and occurrence).
Main risk is completeness so auditor has to be concerned about any long-term loans that are NOT recorded.
Long-term loans must be reflected at amortised cost using the effective interest rate – for normal long loan (e.g. fixed term
or no premium on repayment) the effective interest rate is the annual interest rate charged as per the agreement. Can have
loan where there is a low interest rate, but premium must be paid at the end of the loan term – then has to be amortised at
the effective interest rate to spread the full cost of the loan over the term of the loan (similar to a debenture redeemable at a
premium).
Audit of Long-term loans
Opening inspect prior year workpapers and prior year financials closing balance to confirm that the
balance – opening balance agrees
Occurrence : inspect Memorandum and Articles of Association to see whether :
 company authorised to take out long-term loans or if it contravenes any part of entity’s
regulations
 inspect the cash receipts journal, deposit slip / bank statement for evidence of the receipt of
the correct amount
Accuracy,
cut-off,  reperform the calculations and casts to confirm that the cash received from the loan is in
classification accordance with the loan agreement (accuracy)
:
 recalculation the effective interest rate based on the terms of the agreement and compare
to the effective interest rate used by the client in the amortisation calculation

 inspect the journal entry raising the finance cost and increasing the loan liability account
and agree the amounts to the amortisation calculation

Completeness
obtain specific representations from management that all long-term loans have been included
–

Review financial records, minutes of directors meetings, audit committee and steering
committee meetings and correspondence for evidence of unrecorded loans

Obtain 3rd party confirmation from all long-term loan creditors from prior year who are no
longer long-term liabilities or whose balances are significantly lower in the current year

Enquire and confirm as to the source of funding for any major acquisitions identified during the
audit of fixed assets
Match interest payments to long-term loans to confirm each loan to which the interest
payment relates
Perform analytical reviews e.g. compare current year balances on loan accounts to interest
paid in prior years
Closing trace the closing balance on the loan account (after the finance charge / amortisation
balance – adjustment) to the trial balance
presentation  they are complete in terms of ISA’s (i.e. details of any security which has been granted to
and loan granters, bond over fixed property and dates and conditions of any redemptions or
disclosure - conversation options)
auditor must
inspect the
disclosures in  consistent with evidence gained on the audit
the financials
and consider if
:  amounts, facts, dates etc are accurate and agree with evidence

 classification of the information disclosed is appropriate

 wording of the disclosure is clear

54
Control risks associated with long-term loans

validity/existence The risk that the long-term loan may be unauthorised

completeness The risk that the long-term loan may be omitted and is not
reflected in the balance sheet
valuation The risk that the long-term loan is not reflected in the balance
sheet at the correct value
obligation The risk that the long-term loan is not a valid obligation of the
company
presentation and disclosure The risk that the long-term loan is not properly disclosed in the
financial statements

Audit objectives for the verification of interest-bearing borrowings - to obtain satisfaction that interest-bearing borrowing :
 exists (validity / existence)
 is shown on the Statement of Financial Position (completeness)
 shown on Statement of Financial Position at the correct value (valuation)
 is valid obligation of the company (occurrence / obligation)
 has been properly disclosed in the financials in accordance with statutory requirements (disclosure)

Internal controls introduced to ensure that a mortgage loan

Tests of control to ensure that the long-term loan is duly
negotiated to purchase property has been duly authorised
authorised and accurately accounted for in the financial
and fully and accurately accounted for in the accounting
statements
records :
 effecting of the bond should be authorised at a general  1. Inspect the memorandum and articles of association of
meeting the company to ensure that management or the directors
are authorised to enter into loans.

 must be minuted directors have power of attorney at  2. Inspect the minutes of directors and/or shareholders
the meeting to sign the loan contract on behalf of the meetings to ensure that the loan was properly
company authorised.

 copy of the registered mortgage deed should be filed in  3. Inspect the original loan agreement for validity, by
the loan agreements file and recorded in the register of checking the information and original signatures on the
loans and mortgages contract.

 4. Obtain a copy of the registered mortgage deed and

compare it to the loan agreement. Ascertain if the
mortgage is recorded in the register of loans and
mortgages.

 independent person must compare the accounting  5. Determine if an independent person compared the
record of the transaction with the mortgage deed for accounting entries of the transactions with the mortgage
accuracy – independent person should also check if the deed for accuracy.
contract has been signed by the authorised agents
55

Finance lease liabilities

Way of “acquiring” an asset – many leases are simple operating lease where lease rentals paid are written off in the
Statement of Comprehensive Income, but financial leases are different and the company has to raise an asset and a
corresponding liability (both of which have to be audited).
Lease is classified as a finance lease that must be capitalised if any of the following conditions are present :
 lease agreement transfers ownership of the asset to the lessee at the end of the lease term or
 lessee has the option to purchase the asset at a price significantly lower then the fair value at the date that the option is
exercisable (bargain purchase option)
 lease term is for the major part of the leased asset’s economic life
 present value of the minimum lease payments (at the inception of the lease) amounts to a least substantially all of the
fair value of the leased asset
 leased asset are of specialised nature such that only the lessee can use them without a major modification
 if lessee cancels the lease then the lessor’s losses caused by the cancellation are borne by the lessee
 gains or losses from the fluctuation in fair value of the residual value accrue to the lessee
 lessee has the ability to continue the lease at a rent that is substantially lower then market rent
If lease is to be capitalised as a finance lease then asset and corresponding liability must be recognised in the Statement of
Financial Position which means :
1. asset must be raised at its fair value – or if lower then the present value of the minimum lease payments discounted at
the interest rate specified in the lease agreement
2. any direct lease costs incurred by the lessee can also be capitalised
3. asset must be depreciated - if not reasonably certain that ownership will transfer to the lessee then asset must be
depreciated over the SHORTER of the lease term or its useful life. If reasonable certainly that the ownership will
transfer to the lessee the asset is depreciated over its useful life
4. as the lease payments are made so the payment must be apportioned between finance charges and the reduction of
the liability
5. current portion of the lease liability must be disclosed under current liabilities
56
Audit of Finance lease liabilities
Occurrence / obligation and existence – inspect the finance lease for pertinent details :
 name of lessor and lessee (should be client)
 amount of minimum lease payments
 term of lease
 other important conditions (e.g. penalties for late payment of lease rental
Inspect the minutes of the directors and steering committee’s meetings authorising the lease agreement
Inspect the Articles of Association to confirm that they have been complied with and that the borrowing
powers / conditions haven’t been breached
Enquire of management and refer to prior working papers to confirm that new finance lease will not breach
contracts in respect of existing finance agreements
Determine if the lease qualifies as a finance lease (i.e. the risks and rewards of ownership have
substantially transferred to the lessee.)

Completeness – obtain specific representations from management that all finance leases have been included
Review financial records, minutes of directors meetings and correspondence for evidence of unrecorded
liabilities (e.g. uses of leases to provide off-Statement of Financial Position finance) that should be
classified and treated as finance leases
Enquire and confirm as to the source of funding for any major acquisitions identified during the audit of
fixed assets
Obtain schedule of all leased assets and by inspection and enquiry determine if any leases that are
classified as operating leases should be finance leases
Obtain a schedule of all lease payments and match them to lease agreements to confirm that all leases
have been identified
Confirm by scrutiny of the agreements that all finance leases have been identified and capitalised
Perform analytical reviews – e.g. compare current year balances on finance lease accounts and lease
payments paid to prior year
Accuracy, cut-off, classification – Initial recognition :
 obtain independent confirmation of the fair value of the asset which has been leased by enquiry of
the supplier, inspection of trade journals etc (fair value probably won’t appear in the lease
agreement)
 if direct lease costs have been capitalised then confirm by enquiry and inspection of the
supporting documentation that the costs are valid lease costs applicable to the leased asset and
were incurred by the lessee
Depreciation – leased asset
 by enquiry of management and evaluation of the terms of the lease agreement, determine if the
asset should be depreciated over it’s useful life or the term of the lease
 determine by enquiry of the directors if the residual value applicable to the leased asset is
reasonable
 determine by enquiry of the directors if the “component” method of depreciation is applicable and
if so if the allocation of costs of the components is appropriate (can also enquire independently of
the supplier)
 enquire of the directors as to whether the depreciation method is appropriate and confirm by
reference to the minutes that the method has been reviewed by the directors (must be done
annually)
 reperform the depreciation calculation
 enquire of the production director is any impairment of the assets is required
Lease payment
 reperform the implicit interest rate calculation
 reperform the apportionment calculation of the leased payments and trace the position of the
amounts apportioned to the liability account (and finance cost account)
 reperform the current portion of the lease liability calculation and trace the reclassification to the
GL / trail balance and financials
General
 cast the finance lease liability account
 securitise the dates on documentation to confirm that the leases, repayments etc relate to the
accounting period under audit
Assertions pertaining to presentation and disclosure - auditor must inspect the disclosures and consider if :
 they are complete in terms of ISA’s (i.e. accounting polices, amounts and commitments, terms of leases,
encumbrances on any leased assets, reconciliation between the total of future minimum lease payments at
Statement of Financial Position date and their present value)
 consistent with evidence gained on the audit
 amounts, facts, dates etc are accurate and agree with evidence
 classification of the information disclosed is appropriate
57
 wording of the disclosure is clear
Disclosures pertaining to non-current liabilities are extensive and auditor will probably have to carry out
extensive procedures specifically for the disclosure (in addition to those for transaction and balance assertions)
58
PROPERTY, PLANT & EQUIPMENT

two possible ways of valuing PPE – either cost model or revaluation model and this must apply to the entire class of PPE.

Cost model Revaluation model

After recognition as an asset, PPE item is carried at its  After recognition as an asset, PPE item whose fair
cost, less any accumulated depreciation and any value can be measured reliably is carried at its fair
accumulated impairment losses. value at the date of the revaluation, less any
subsequent accumulated depreciation or subsequent
accumulated impairment losses.

Depreciation – IAS 16 states that directors should allocate the cost of each item of PPE to its significant parts and
depreciate each part separately when :
 the cost of the part is significant in relation to the total cost of the item
 the part and the remainder of the unit have different useful lives or
 different residual values.

If item has been broken down into significant parts then each part must be recorded in the fixed asset register separately.
IAS 16 states that depreciable amount of an asset should be allocated on a systematic basis over its useful life :
Depreciable amount = cost / revalued amount less the residual value
Residual value = estimated amount that entity would obtain if disposing the asset after deducting the estimated
costs of disposal if the asset was already of the age and in the condition expected at the end of its useful life
Useful life = either :
 period over which the asset is expected to be available for use by an entity or
 number of production or similar units expected to be obtained from the asset by the entity.
Also states that residual value and useful life must be reviews at least at the end of each financial year and any changes
should be accounted for.
Depreciation method used must reflect the pattern in which the assets future economic benefits are expected to be
consumed – e.g. straight line method, diminishing balance, unit of production method.
59
Audit procedures – property, plant and equipment

Existence  extract a sample of assets from the fixed asset register (including some additions for the year)
 enquire of senior staff if major equipment has replaced old equipment (e.g. factory manager) and
follow up to see if it was disposed of
 physically inspect the assets selected, matching them to the description in asset register using serial
numbers. if asset cannot be physically verified for existence (e.g. mobile equipment used in remote
area) then must seek corroborating evidence to verify it
 conduct search of unrecorded disposals by :
 analysing the sundry revenue account / cash receipts journal from receipts form disposals on fixed
assets and confirm that the item that was sold is included in the list of disposals
 during physical inspection of assets take note of any evidence of fixed equipment which has obviously
been revamped and follow up to determine if a disposal has taken place
 inspect correspondence with the insurance company to identify any fixed assets that have been
removed from the list of insured items
 look for evidence of expenses related to PPE which are no longer being paid or are significantly
reduced (e.g. rates, vehicle license fees) and confirm that the assets to which these expenses applied
were disposed of.
 reconcile disposals per the capital budget with the client’s list of disposals
 Obtain a management representation letter regarding the existence of property, plant and equipment.

Completeness  inspect repairs and maintenance for material items which represent acquisition of plant and equipment
that have been allocated as expenses
 if physically verifying assets for existences then select sample of fixed assets and trace them to the
fixed asset register agreeing description, asset numbers etc
 review creditors and cash payments for fixed asset purchases and confirm that they are recorded as
fixed assets
 review lease agreements and enquire of senior personnel for evidence of any assets which have been
leased in terms of finance leases but which haven’t been capitalised
 Obtain a management representation letter regarding the completeness of property, plant and
equipment

Rights  determine if there are any changes in the rights of assets held at the beginning of the financial year (in
opening balances) by enquiry of management and inspection of the director’s minutes
 confirm that additions are in the name of the client by inspecting purchase documentation and
documents of title
 confirm that the client is not behind in payment if the assets are still being paid for (cos rights may be
jeopardized) by inspecting payment records and supplier statements and enquiring from the financial
manager (or seller)
 inspect lease agreements for assets that have been capitalised to ensure rights and rewards of
ownership have passed to the client
 obtain evidence of any encumbrances on fixed assets (e.g. offered as security) by enquiry of
management and inspection of :
 prior year working papers
 minutes
 loan agreements
 bank and other 3rd party confirmations.

Valuation /  agree the opening balances on the summary schedules to prior year work paper / general ledger
cost  reperform all casts and extensions in the fixed asset register, summary schedules and supporting lists
of additions and disposals
 reperform reconciliation of the fixed asset register to the fixed asset accounts and accumulated
deprecation accounts in the GL following up on all reconciling items
 agree by inspection the closing balances on the summary schedules to the GL and financial
statements.
60
Cost of additions
Occurrence :
 select a sample of additions from the fixed asset register and trace to capital budget, minutes of directors meetings and
purchase requisitions for evidence of authority for the acquisition
 inspect the asset itself and cross reference description, serial number etc to purchase documentation
 inspect the purchase documentation (invoice / contract) to confirm that it is made out to the client, is for that asset and is
signed
 inspect payment records to confirm that payment was made for the asset
Accuracy, classification, cut-off :
 by inspection of the purchase documentation confirm that the cost of the asset includes the correct cost price, correct
shipping charges, import duties etc and costs of installing and commissioning the fixed asset
 if asset is imported then use reperformance to confirm that :
 it has been raised in the company’s records at the spot rate on transaction date
 all relevant shipping costs, import charges etc have been included in the cost and converted from the foreign
currency at the correct rate (transaction date)
 if entity has split significant parts of one item then confirm that the allocation is fair by enquiring with the directors and
inspecting the relevant documentation from the supplier
 if asset has been installed then obtain a schedule of the installation costs and :
 agree it to the cost calculation for the asset
 inspect the supporting documentation in respect of materials and wages used in installation for valid, accurate and
complete inclusion (especially to be sure there is no inclusion of non-relevant expenses e.g. repairs)
 discuss reasonableness of any other expenses included with the financial director
 by inspection of purchase documentation and ledger accounts ensure that vat hasn’t been included in the cost if client is
a vendor
 inspect the dates on all documentations to confirm that transaction is in the correct accounting period (cut-off)
 trace the posting from source to the GL to confirm that the transaction has been recorded in the proper accounts
(classification)

Disposals
Occurrence :
 inspect the supporting documentation used to approve the disposal for an authorising signature
 by reference to the capital budget, confirm authority for the disposal
 trace the proceeds of the sale to the receipts records / deposit slip / bank statement
Accuracy, classification, cut-off :
 obtain original cost / revalued cost of the disposed asset, dates of acquisition and disposal from the fixed asset register
and :
 recalculate accumulated depreciation to date of disposal
 recalculate the profit / loss on sale (if there was an impairment loss then not loss on sale, but if no impairment
assessment then the loss is a loss on sale)
 inspect the dates on all documents to confirm that the disposal has been recorded in the correct accounting period
(cut-off)
 confirm by inspection that the asset account and accumulated depreciation account in the GL have been correctly
amended and that the disposal has been correctly and completely recorded in the fixed asset register (accuracy
and classification)

Valuation – depreciation allowance :

 confirm by enquiry of directors that the accounting policy for depreciation is consistent with prior years
 if component method of depreciation is used then confirm that the allocation of the cost of the components is fair and
reasonable by enquiry of management, scrutinising of purchase documents or enquiry of the supplier
 obtain a representation letter from management confirming that they have reassessed the useful life and residual value
of the assets including the separate component if applicable
 review the changes to useful life and residual values and assess if reasonable. Obtain reasons from management and
if needed consult with an expert to confirm
 when physically inspecting the assets enquire about damaged or not in use assets and establish if the items should be
written down
 extract a sample of assets that were acquired some years prior (4 or 5) and compare their physical condition to their
depreciated values
 inspect and analysis the profits / losses on disposals of fixed assets and consider if the deprecation method is
reasonable (i.e. estimates of useful life and residual value are appropriate)
 reperform the depreciation calculations for the year to ensure accuracy and compliance with the depreciation policy and
that the amounts are correctly posted
 discuss the reasonableness of the depreciation allowance with management and enquire into the approval procedures
adopted (e.g. does the financial director review the allowance)
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 perform an analytical review on the allowance e.g. comparing prior years by asset grouping and in relation to the
additions and disposals for the year
 discuss with senior personnel if there has been anything that might affect the useful life of an asset
Valuation – impairment
IAS 36 states that an entity must assess if there is any indication that an asset may be impaired at each reporting date. If
there is impairment then the recoverable amount of the asset must be estimated so that the impairment loss can be
calculated (the amount by which the carrying amount of the asset exceeds its recoverable amount). Auditor will probably
have to rely on the directors to identify and quantify the impairment cos it is quite subjective, but the auditor should :
 evaluate the process by which the entity identifies and quantifies impairments
 inspect and evaluate any documentation which might support the directors on impairments with regard to assumptions
made, methods or bases of quantification and rates or percentages used
 discuss with management :
 any assets whose market value has declined significantly more then would be expected
 any significant changes that might have taken or might be about to take place which would adversely affect the
entity in the technological market, economic or legal environments in which the entity operates
 any evidence obtained on the obsolescence or physical damage to assets identified during the audit
 assets lying idle
 plans to discontinue certain operations
 evidence from internal reports (e.g. monthly management reports) that suggest that the economic performance of
an asset is worse then expected

Revaluations
If use revaluation model then any item of PPE is carried at a revalued amount - its fair value (being the amount for which an
asset could be exchanged between knowledgeable willing parties in an arms length transaction) at the date of revaluation,
less any subsequent accumulated depreciation and impairment losses.
Auditor will still use basic audit procedures, but if the revaluation is determined from market based evidence evaluated by an
expert (e.g. property evaluator), then auditor will have to use ISA 620 to assist in the audit of the revaluation.
If revaluation is done internally by directors then auditor will use the supporting documentation to evaluate the
reasonableness of the methods used, assumptions made and the interpretations by the directors of any available data (must
try to verify as much as possible).
If vehicle or motor equipment then can use the vehicle book value as the fair value.
Auditor must also pay careful attention to the treatment of accumulated depreciation at the date of revaluation and after. All
calculations must be checked along with the treatment of the increases or decreases in the financials (increases to equity in
revaluation surplus, and decreases are recognised in profit and loss).
Auditor must confirm that ALL the items in a class of assets have been revalued and that the details of the revaluations have
been properly disclosed.

Assertions pertaining to presentation and disclosure

Auditor must inspect the disclosures and consider if :
 they are complete in terms of ISA’s as far as :
 measurement bases used for determining the gross carrying amount of each class of PPE
 depreciation methods used
 reconciliation of the carrying amount at the beginning and end of the period showing additions, revaluations,
impairment and depreciation
 restrictions on title, capital commitments
 amount of impairment losses recognised in profit and loss during the period
 consistent with evidence gained on the audit
 amounts, facts, dates etc are accurate and agree with evidence
 classification of the information disclosed is appropriate
 wording of the disclosure is clear
Disclosures pertaining to PPE are comprehensive and auditor will probably have to carry out extensive procedures
specifically for the disclosure (in addition to those for transaction and balance assertions)
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Audit of and buildings (property) transactions
Land tenure in SA has to be registered in the name of the person or juristic person (company / CC / trust).
When land is purchased :
 buyer makes a written offer for the purchase of land to the sell – when this has been accepted then document is signed
by the seller and the witnesses and a valid contract of purchase is made
 if contract of purchase contains preconditions such as obtaining finance then there is a period of time for this to be done
in the contract
 buyer then applies in writing to a finance institution for a bond and the contract of purchase is handed to a conveyancing
attorney who takes care of the registration of the land in the name of the purchaser and the registration of a mortgage
against the property
 buyer normally pays the conveyancer the cost of registering the property and the mortgage. Registration cost includes
transfer duties or vat and those are then paid over to government by the conveyancer along with a statement of the
amounts payable
 financial institution to which the buyer applied then furnishes guarantees to the conveyancer when the financing has
been approved and the conveyancer proceeds with the transfer of ownership
 deed of transfer showing the buyer is the new owner is registered with the Deeds Office and the mortgage deed is also
registered (details of the mortgage appear on the deed of transfer as an endorsement). The original deed of transfer
and mortgage deed are issued to the buyer but normally placed in the custody of the mortgagee (bank)
 conveyancer informs the bank that has granted the mortgage as well as buyer and seller when the transfer of ownership
has been completed and then the financial institution pays the purchase price to the seller via the conveyancer
 conveyancer furnishes buyer with the statement of account & copies of the deed of transfer & the mortgage deed.

Substantive procedures to audit the purchase of land and buildings :

 inspect the minutes of the directors / shareholders meetings at which the purchase of the business premises was
authorised
 obtain a certificate from the bank stating that the property was registered n the name of the company or inspect the
original deed of transfer
 perform a deeds search at the Deeds Office and make certain that the property is registered in the name of the
company. Compare the cost price of the property as shown on the deed of transfer with the accounting entries
 inspect the municipal accounts to make certain that they are made out to the company and determine what the
municipal valuation of the property is
 perform a physical inspection of the land and buildings to make certain that they do exist and compare the particulars of
the premises with the particulars shown on the deed of transfer
 inspect the posting of the journal entry and the payment of the transfer and registration costs to the fixed property
account in the GL
 inspect the journal entry in which the cost price of the property was brought to book :
fixed property dr
mortgage loan – bank cr
 inspect the ledger account to determine if it contains the correct description of the fixed property and if the total cost of
the property is shown in the account

Substantive procedures relating to the attorney’s costs and deed of transfer :

 inspect the invoice and other correspondence from the attorney in connection with the transfer and registration of the
property and made certain that the particulars of the property correspond
 enquire from management if the transaction was authorised for payment by the designated person
 trace the payment of the attorney’s costs in the cash payments journal / cash book to the corresponding entry on the
bank statement
 inspect the bank stamped returned paid cheque and make certain that the particulars agree with the cash payments
journal and that the cheque was made out to the attorney in question
 trace the posting of the registration and transfer costs from the cash payments journal to the land and buildings account
in the GL

Audit of other fixed / non-current asset transactions

Other movable fixed asset audits focus mainly on obtaining evidence of the completeness, occurrence, existence and
measurement of the fixed assets.
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Substantive procedures to audit the ACQUISITION of motor vehicles

Inspect the minutes of meetings where the acquisition of the new motor vehicles Occurrence
was authorised
Review the current year budget to ascertain that the capital expenditure was Occurrence
budgeted for and as such was authorised
Inspect the purchase documentation (purchase invoice, purchase contract) to Occurrence
confirm that it is made out to the client; inspect that the documentation is signed
and that it is applicable to the relevant motor vehicles
Compare the description, engine and chassis number, registration number, make Accuracy, classification
and model in the purchase contract to the particulars recorded in the fixed asset
register and agree the recorded cost to the amount recorded in the general ledger
asset account
Physically inspect the acquired vehicles and compare the description, engine and Accuracy, existence,
chassis number, registration number, make and model to the fixed asset register completeness
to confirm that the acquired asset was added
By inspection of the purchase invoices and purchase contracts confirm that the Accuracy, classification
costs of the new motor vehicle were correctly recorded in the fixed asset register
and motor vehicle account in the general ledger
 The correct cost price
 Correct shipping charges, import duties and insurance (if applicable)

Inspect the posting of the debit entries from the cash payments journal or general Classification
journal (in the case of financing the acquisition) to the motor vehicle asset
account in the general ledger
In case of a financing the transaction, inspect the finance documentation, for Accuracy
example, lease agreements or hire purchase agreements in the case where
finance was obtained for the acquisition of the new motor vehicles. Agree the
total amount to the amount recorded in the non-current liability account in the
general ledger
Re-perform all casts and calculations on the purchase documentation, including Accuracy
Value Added Tax (VAT), and confirm that (VAT) has not been included in cost of
the new motor vehicles. Agree to the motor vehicle account in the general
ledger
Inspect the dates on purchase invoices and purchase contracts to confirm that Cut-off
the purchase transactions have been recorded in the correct accounting period in
the general ledger motor vehicle account
Inspect insurance documents and correspondence with insurance companies for Occurrence,
any vehicles which have been added to the list of insured items to confirm that completeness
new vehicles were added
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Substantive procedures to audit the purchase of a fixed asset item that was paid for by cheque :
 inspect the purchase requisition for the purchase of the fixed asset and make certain that it was authorised by the
responsible person
 scrutinise the particulars on the invoice and cashed cheque and compare them with the information recorded in the cash
payments journal
 check that the particular cheque payment for the purchase of the fixed assets appears on the bank statement
 compare the information shown on the invoice with the entry in the fixed asset register and make certain that it has been
correctly recorded and classified and record on the correct date
 inspect the posting from the cash payments journal to the asset account in the ledger for accuracy

Substantive procedures for the purchase of a new vehicle :

 examine the minuted authorisation and make certain that the purchase of the vehicles has been properly authorised
 confirm the particulars in the fixed asset register by inspecting the supplier’s invoices, trade-in credits, comprehensive
insurance, hire registration certificates and current licensing certificates
 agree with the accounting treatment of the transaction in the cash payments journal / cash book with the particulars in
the fixed asset register
vehicles dr
bank cr
 make certain that the vehicle was brought to book in the correct category and on the correct date
 examine the cashed cheque and make certain that the cheque was made out to the supplier in question and that the
amount agrees with the amount in the cash payments journal / cash book
 trace the payment of the cheque to the company’s bank statement
 inspect the registration certificates and make sure that vehicles have been registered in the name of the company
 enquire about the company’s depreciation policy regarding the vehicle and make sure that it is consistent with the policy
applied during the previous year
 recalculate the depreciation on the vehicles of the period in question and check if the amount agrees with the
depreciation write-off in the GL
depreciation dr
accumulated depreciation – vehicles cr
 examine the postings of transactions to the relevant ledger account.

Vehicle registration / ownership

When vehicles are purchased or ownership is transferred then transactions have to be legally registered. Once proof of the
roadworthiness has been received then the KZN Transport department gives the vehicle a registration number and issues a
registration certificate showing the particulars of the vehicle (chassis and engine number) and the owner (ID number and
address). Annual licensing fees are paid and a licence disc received.
Details of the vehicle must then be entered in the fixed asset register and can then be compared with the annual particulars
on the vehicle during a physical inspection.
Auditor should also check that the insurance policies, repairs and maintenance of the vehicles and also the writing off of
depreciation at the appropriate rates.

Substantive procedures for investing balances

Land and buildings (property) balances - ownership of land can be ascertained by examining the deed of transfer to
determine if the land is registered in the name of the client.
To establish if the deed of transfer is genuine must inspect the original deed of transfer at the Deeds Office (best way of
doing it) or at the premise of the bank who holds the mortgage, or must obtain a certificate from the bank stating that the
right of ownership rests with the client.
Further evidence of existence and right of ownership can be got through :
 physical inspection of the land
 examination of municipal accounts
 insurance contracts giving particulars of the land
 examination of architect’s certificates and building contractors contracts if buildings have been built
Auditor must make sure that the land is shown at a reasonable value in the financials (normally cost or at revaluation
amount). No depreciation on property.
If property serves as security then must be disclosed in the financials and cross-referenced.
Right of ownership of buildings is linked to the right of ownership of the land on which they stand.
Auditor’s substantive tests of details of fixed asset balances are performed to obtain sufficient and appropriate evidence of
the completeness and existence of the assets that are shown in the financial statements.
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Audit objectives Substantive procedures

To prove : All recorded assets exist Observe that the fixed assets accounted for in the
fixed asset register do exist
Depreciation on fixed assets has been Recalculate the depreciation on fixed assets
calculated correctly
Information that should
be included in a fixed asset register :
 description
 identity number  dates of purchase and disposal
 rate of depreciation  consideration received on disposal
 cost  location of the unit / person responsible for the unit
 annual depreciation  floor area occupied by the unit
 estimated life and estimated scrap value  annual operating costs in respect of the unit
 repairs performed on the unit since purchase  horsepower of the unit
 initial and wear-and-tear allowances granted by SARS for income tax purposes and the present tax value of the unit

Substantive procedures for the BALANCE of vehicles at year-end :

 examine the registration receipts and current licence receipts for the vehicles to establish if they are registered in the
name of the company
 carry out a physical inspection of the vehicles and check if the description in the fixed asset register is a true reflection of
the physical vehicles
 consider the reasonableness of the depreciation provided for on the vehicles in the current year taking into account their
current physical condition. Make sure that the basis on which depreciation was calculated is the same as the previous
year
 inspect the comprehensive insurance documents for the insured value of the vehicles and compare the insurance value
with the current replacement value
 inspect the repairs and maintenance logbooks to verify valuation of the vehicles
 obtain a certificate from management regarding the physical condition and ownership of the vehicles
 ascertain if there has been proper disclosure of the vehicle in the Statement of Financial Position or notes (i.e. cost price
less accumulated depreciation)
see questions in 9.3 of tutorial letter 102 and answers in 9.3 of tutorial letter 103

Study guide pg 197

Borrowings are a non-recurring transaction that is audited in full – the substantive procedures will focus on obtaining
evidence of the completeness, occurrence and measurement and the rights and obligations that result.
Great importance is placed to the investigation of appropriate authorisation, loan contracts, compliance with repayment
conditions and acquisition of external audit evidence from loan institutions.

Jackson & Stent pgs 17/25 & 17/26

Analytical procedures – analysis of significant ratios and trends and then investigation of fluctuations and relationships
that are inconsistent with other relevant information or that differ from predicted norms.
Analytical procedures are substantive in nature and are used :
 as risk assessment procedures in obtaining an understanding of the entity and its environment and the risk of material
misstatement
 to substantiate an assertion when analytical procedures will be more efficient or effective then tests of details e.g.
comparison of wages, week to week etc may provide sufficient evidence as to the fair presentation of the wage expense
 provide corroborative evidence in the final review stage of an audit.
Either a comparison of entity’s financial information with prior year’s information, budgets and forecasts, similar industry
information (industry averages) or divisions within the entity, OR study of relationships about elements of financial
information (e.g. sales and sales commission), or between financial and non-financial information (e.g. payroll costs and
number of employees). Can also be used as part of predictable pattern based on entity’s experience (e.g. gross profit
percentage).

Auditor must decide if analytical procedures are appropriate for producing sufficient appropriate evidence :
 assessment of the risk of material misstatement – the higher this risk the more likely it is that more tests of details will be
appropriate
 tests of detail already done on the assertion – then analytical procedures may provide good corroborative evidence
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No point performing analytical procedures on unreliable data. Auditor must consider :
 source of the data – external evidence is better then internal evidence
 comparability – must compare “apples with apples” e.g. ratio in a wholesale business will not be comparable with a
ratio in a retail business
 nature and relevance – if going to compare to a budget then is it a good well-thought out budget or just random
guesses
 controls over preparation of the data – poor control over validity, accuracy and completeness results in unreliable
data

Auditor needs to consider if the results of the analytical procedures are specific enough to identify material misstatement.
Must consider :
 availability of information both financial and non-financial
 extent to which the information can be broken down
 inherent predictability of the information e.g. no point conducting extensive analytical review on information that has no
predictable pattern and fluctuates all the time.
Acceptable fluctuations differ from person to person as they are very objective and are based on professional judgement.

Remember that just working out ratios and trends isn’t of much value on their own – have to identify and follow up on
significant fluctuations and inconsistencies efficiently and effectively. May have to perform additional audit procedures and
must obtain corroboration of any explanations given by the client.

Study guide pg 198

Substantive procedures to be performed when auditing a mortgage loan :
 inspect the Memorandum and Articles of Association to determine the existence of borrowing powers in respect of the
mortgage loan
 inspect the entity’s minutes for authorisation of the transaction
 inspect the mortgage deed of hypothecation to make sure that it is a legally valid document that has the seal of the
Registrar of Deeds
 inspect the mortgage deed to confirm the interest rate and the repayment conditions applicable to the mortgage loan
 compare the description of the encumbered property in the mortgage deed corresponds with the description of the
company’s land and buildings in the GL and financials
 obtain direct confirmation from the Deeds Office that the mortgage has been registered and that the registered
mortgage appears as an endorsement on the Deed of Transfer
 obtain direct confirmation from the seller that the total purchase price was received and that no amount is owing
 enquire from the bank or inspect correspondence from the conveyancing attorney to ensure that the full purchase price
has been paid to the seller
 obtain and inspect a statement from the bank giving the particulars of the bond loan transactions and make sure that the
total purchase price appears as a disbursement on the correct date
 inspect the journal entry in which the mortgage loan is accounted for to check for accuracy and agree the particulars
with the GL
Auditing of unsecured loans with regard to the transfer, registration and attorney costs payable :
 inspect the Memorandum and the Articles of Association to determine the existence of borrowing powers in respect of
the unsecured loan
 inspect the authorisation for the transaction in the minutes of meetings
 inspect the loan agreement to make certain it has been signed by the authorised persons
 inspect the loan agreement to establish the details of the interest rate and the repayment conditions applicable to the
unsecured loan
 inspect the attorney’s invoice for the transfer, registration and attorney’s costs and agree these costs with the loan
amount
 if the loan amount was paid over directly to the attorney’s then obtain direct confirmation that the full amount was paid
over to the attorney, or inspect the deposit slip if the money was paid into the bank account
 inspect the journal entry in which the unsecured loan is accounted for to check for accuracy and agree the particulars to
the GL

Financing transactions and balances are infrequent and documentation is normally external and complete. As transactions
are of exceptional nature and the amounts are material, the auditor must pay attention to the audit of financial transactions
and balances and subject them to a thorough and complete audit.
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STUDY TOPIC 10
INVESTMENT AND CASH
Accounting system for cash and bank balances consists of the actions / activities from the time cash is received to the time
that it is deposited into the bank account. Normally includes :
 counting cash on hand and agreeing it with the total according to the accounting records
 receipts being issued for amounts received
 receipts accounted for numerically in the cash receipts journal and then analysed
 preparing a bank deposit slip and agreeing the total with the corresponding receipt and total in the cash receipts journal
 depositing the money into the bank account and using the stamped duplicate bank deposit slip to provide evidence of
the deposit
 bank statement received showing all bank transactions and reconciled with the cash receipts and payments journal
(cash book)
No difference in audit procedures if bank account is dr or cr.

Audit objectives are based on the assertions applicable to Statement of Financial Position balances :

Audit Objectives of BANK BALANCES – to obtain satisfaction that

Completeness  recorded cash balances include the effects of all cash and bank transactions that have occurred
during the period.
 all inter-bank transfers have been recorded in the correct accounting period

Existence  recorded cash and bank balances exist at the Statement of Financial Position date

Accuracy /  total cash and bank balances are reported in the Statement of Financial Position at cost
cut-off / determined in accordance with GAAP and the organisation’s accounting policies applied on a
classification constant basis

Valuation  total cash and bank balances are reported in the Statement of Financial Position at cost
determined in accordance with GAAP and the organisation’s accounting policies applied on a
constant basis, and are realisable at the amounts stated there

Rights and  the organisation has legal rights to all cash and bank balances reflected in the Statement of
obligations Financial Position at Statement of Financial Position date
 security provided over assets of the entity to secure loans granted to the entity by its bankers
have been identified

Presentation  cash and bank balances are properly identified and classified in the financial statements and,
and disclosure where offset is permitted, this has been done so in accordance to GAAP

Substantive procedures of the audit of bank and cash

Assertion – rights and existence (the company holds or controls the right to the bank balance and they actually
exist)
Primary source of evidence to the existence of and rights to bank accounts is the letter of confirmation. Done by :
 auditor sends standard SAICA bank confirmation letter to the bank after permission is obtained from the client
 bank requested to return the confirmation directly to the auditor at his address
 bank must be asked to supply balances and other details NOT to confirm the auditor’s details, but auditor must supply
account numbers
 must confirm for all sorts of bank accounts (current, call accounts etc)
 banks take a while to reply so must ensure it is done timeously and must clearly stipulate the date at which balances are
required
 on receipt of the letter from the bank, auditor must check all the information has been supplied and follow up on any
discrepancies between bank letter and other documentation auditor has on hand
 confirmation must also advise of any encumbrances on bank balances
 minutes of directors meeting must be scrutinised for any evidence of bank balances being encumbered

Assertion – completeness (all bank balances which have been recorded)

Always risk that company is concealing money in unrecorded bank account – if auditor suspects this then must call in
forensic audit experts. Otherwise normally audited by :
 comparing the number of type of bank accounts held at current year-end with those held at the previous year-end and
following up on closed accounts
 requesting the bank to specifically comment on whether all accounts have been included in the bank confirmation
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 being alert to the possibility of other bank accounts when performing routing audit procedures (e.g. vouching payments,
scrutinising minutes, cash budgets etc)
 making specific enquiries of management about foreign bank accounts if there are imports / exports in the company

Assertion – valuation (the bank balances are included in the financial statements at appropriate amounts)
Bank confirmation – primary source of evidence for bank balances (bank should be able to pay the balance over)

Bank reconciliation – unlikely that balance per confirmation letter will agree with the balance in the “cash book” due to
outstanding items at year-end, but the auditor should reperform / test the client’s bank recon. Also provides evidence that
cash and bank transactions have been accurately processed.

Substantive procedures to audit the bank reconciliation at year end

 Agree the opening balance per the cash book (receipts and payments journal) and the bank statement with the closing
balances of the previous bank reconciliation.
 Obtain a bank confirmation letter directly from the bank to certify the bank balance.
 Agree the balance as shown on the bank certificate with that shown on the bank statement and also shown on the
reconciliation.
 Agree the bank balance (totals as shown in the cash receipts and payments journal) with the relevant figure on the bank
reconciliation.
 Ascertain whether all sheets of the bank statement are accounted for by checking the amounts carried forward from one
sheet to the next.
 Examine the reconciliation for the serial numbers and amounts of outstanding cheques.
 Examine the reconciliation for the amount of any outstanding deposits.
 Scrutinise subsequent bank statements to ensure that all cheques and deposits outstanding at the close of the period under
audit were accounted for in the reconciliation statement.
 Observe that the bank reconciliation was approved and signed by a more senior person than the person actually performing
the bank reconciliation on a monthly basis.
 Check the bank reconciliation for any abnormal items.
 Check whether all EFT’s, cheques, deposits and sundry debits (bank charges, bank interest, R/D cheques, etc.) that appear
in the cash book have been ticked off against the details on the bank statements.
 Check the arithmetical accuracy of the bank reconciliation, the cash book and the outstanding list.

Window dressing – client may try to manipulate the relationship between balances in the current assets and current
liabilities by reducing the bank balance and also reducing the creditors by the same amount (can be done by writing out and
entering cheque payments to creditors in the cash book before year-end, but only posting them sometime after year end).
To check auditor should inspect the cut-off bank statement to determine how long has past since year-end before the
cheques were presented and insist on a reversing entry

Transfers – when transfers are made by EFT’s then must scrutinise the documents carefully especially the payee’s account
number and if done prior to year-end then outstanding transfer must appear on the bank reconciliation.
If large payments made just prior to year-end to different bank accounts held by the client then auditor must ensure that
payments and receipts from and into the different banks are accounted for in same accounting period.

Kitting – way of inflating the cash on hand account by using the fact that it takes a few days for a cheque to clear. Uses the
client’s bank accounts held at different banks to transfer money which is shown immediately in the recipient bank account,
but only in the payment bank account when it has cleared through the banking system.

Cash counts – valuation and existence of cash balances verified by conducting cash counts, but must ensure :
 all cash-on-hand is counted simultaneously (so can’t disguise shortfalls by moving it from one fund to another)
 cash must be counted in the presence of the cashier who is responsible for the float
 auditor should never be left alone with cash
 results of the count should be recorded on a workpaper and the cashier an auditor must acknowledge acceptance of
count results by signing the workpaper
 cash counted for should be reconciled as cash float + cash received – cash payments = cash-on-hand
 all receipts and payments of cash must be supported by documentation
 cash received and cash payments documentation must be scrutinised for validity and authority
 posting of cash transactions to the GL account should be tested and cash-on-hand should be agreed to the GL

Presentation and disclosure – main procedure is to inspect the financials to confirm that the bank balances are correctly
presented on the face of the Statement of Financial Position, and that the disclosures required by Companies Act have been
complied with and that they agree with evidence gathered on the audit.
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Substantive procedures for cash and bank balances involve checking :
 amount of cash on hand  bank reconciliation
 bank deposits and withdrawals  cash records additions and balances

Substantive procedures of the audit of cash-on-hand

Best method of checking cash on hand is to carry out a cash count on the last day of the financial year, with the auditor
taking possession of all cash sums until the cash count is carried out to ensure that cash from one fund can’t be used to
supplement another float that is short. Cashier should be present during the cash count with the auditor.
If auditor can’t be present to carry out a cash count on the last day of the financial year then must give instructions that all
the cash on hand on the last day (petty cash, advance funds etc) must be deposited at the bank on a separate deposit slip
on the first day of the new financial year – the deposit slip will then be reconciled with the accounting records to make user
that the cash-on-hand was correct.

Step-by-step description of a cash count :

 obtain possession of cash, cash records, all documentation for the receipt of cash in current use by the cashier and
vouchers for cash payment for the day of the cash count and a few days preceding it

 retain possession of all those items until have :

 counted and listed cash
 have noted last sequence numbers of the cash sale slips, receipts and other relevant documents
 cash payments for the day of the count and few days preceding that have been vouched for or the relevant
vouchers have been listed
 cash on hand has been counted and how the money was made up (notes and coins) has been recorded
 list the particulars and amounts of the following :
 all the cheques on hand
 postal orders and other forms of money
 IOU’s (loans from petty cash)
List must be made in the presence of the cashier and signed to show it is correct and that the money has been handed
back. Can then either verify the accounting records and recon with the theoretical balance now or at a later stage.

Before auditing bank balance must thoroughly investigate the cash receipts and payments journal as both as used in the
final balance of the bank account.

Substantive procedures to ensure that the banking transactions have been completely and accurately accounted
for in the accounting records :
 check the addition in the cash receipts and cash payments journal
 check the postings from the cash receipts and cash payments journal to the GL for accuracy
 check the numerical sequence of cheques in the cash payments journal for completeness
 agree cheque / EFT payments to the supporting documentation
 inspect the numerical sequence of receipts in the cash receipts journal for completeness
 compare the amounts deposited with the deposit slips stamped by the bank
 examine the bank reconciliation thoroughly
 scrutinise the bank account in the GL and investigate any unusual items
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STUDY TOPIC 11
OVERALL REVIEW

General review will be a review of the :

 working papers collected
 GL and
 financials on which the opinion must be expressed.
Auditor must consider the sufficiency of the audit evidence that was collected, the evaluation of the effect of
misrepresentations and the general review of the financial information, the “going-concern” concept and the events after the
Statement of Financial Position date.
Cos of delegation auditor must review work done to make sure it complies with the established control standards.

Factors to be taken into account while reviewing audit working papers completed by assistants – whether :
 sufficient audit work has been carried out in accordance with the audit programme and if the work has been done with
necessary care and competence
 results obtained from work carried out have been adequately documented with regard to the overall audit plan and the
audit programme, assessment of inherent and control risk, audit evidence collected and proposed audit adjustments
 all material audit matters have either been resolved or reflected in the audit conclusions
 objectives of the audit procedures have been achieved
 conclusions drawn are in line with the results of work done and they support the audit opinion.

Auditor has to assess if the total uncorrected misstatements identified during the audit are material. Uncorrected
misstatements are either specific misstatements identified by the auditor (including the net effect of the uncorrected
misstatements during the audit) and the auditor’s estimate of other misstatements that cannot be specifically identified
(projected errors).
If auditor decides that the total of uncorrected misstatements is material then he must consider reducing audit risk by
extending audit procedures or requesting that management adjust the financials.
If management refuses to adjust the financials and the extended audit procedures still leave the auditor thinking that the
total uncorrected misstatements are material then he may have to modify the auditor’s report.

Review of financial information – audit procedure that is carried out to obtain satisfaction that the financial information
contained in the GL is fairly presented in the financials. Normally carried out towards the end of the audit process and
nature of the review will differ depending on the characteristic of the entity. Nature and extent of the audit procedures will
depend on the auditor’s professional judgement.

Auditor would have to consider :

 entity’s compliance with the fundamental account principles
 application of the enterprise’s stated accounting policy
 enterprise’s financial position and results of operations as reflected in the financial information
 presentation and disclosure of financial information in the enterprise’s financial statements
 entity’s compliance with any appropriate statutory requirements and regulations (i.e. Companies Act and Auditing
Profession Act)

Prerequisites for reporting

Before issuing auditor’s report must consider matters pertaining to the GL balances, review of financials as well as :
 review of the GL – during the performance of the audit transactions were selected for auditing and traced all the way
back to the GL for the auditor to determine if the postings to the ledger were correctly carried about and all additions and
calculations of balances have been checked. During the general review the auditor will be able to determine if all the
final adjustments have been done (i.e. arrear and prepaid expenses taken into account and if proper distinction between
capital and income has been consistently maintained). Auditor must also review the GL after year-end to see if any
material events have taken place after financial year-end.
When the financials issued with the auditor’s report are finalised then the auditor should make certain that the amounts
in the financials agree exactly with the nominal ledger balances (so final adjustments have been accounted for in the
financials and the GL and the closing balances of the current financial year correspond with the opening balances of the
next year)
 review of entries in GL – cos wide variety of transactions in GL need to review for any unusual transactions not subject
to normal auditing and must scrutinise authorisation and supporting documentation for all these unusual items
 going concern – one of fundamental principles to bear in mind when preparing financials is that of going concern
concept. If company can continue as a going concern very important during all stages of the audit process and
especially during the final report. If company’s liabilities exceed its assets then company is technically insolvent and
there are doubts if it will be able to trade in future
 disclosure requirements – Companies Act requires that annual financials must contain the particulars specified in
Schedule 4 of the Act and discloses must be as specified. Auditor must therefore have knowledge of the Companies
Act before can evaluate the financials. Financials must also be measured against concept of GAAP
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 ratio analyses and interpretations – analytical review procedures are applied at all stages of the audit process from
planning and execution of audit procedures to final completion of the audit. Is the comparison of financial information
and studying relationships. Can either be calculating accounting ratios, calculating certain trends or the use of
estimation models.
If auditor finds unusual deviations then has to investigate them and try to find satisfactory explanations.

Questions and remarks to bear in mind when carrying out an overall review of issued capital as indicated in a draft
Statement of Financial Position :
 have the disclosure requirements for issued capital been compiled with? – comparative figures for the previous period
have to be shown to comply with the Companies Act, and if issued capital then the authorised and issued share capital
must be indicated as to the type of shares e.g. par value shares
 were any shares issued during the current financial period?
 do the particulars of issued capital in the Statement of Financial Position agree with the balance of the issued capital
account in the GL?
 has the planning of the audit of issued capital been properly documented in the working papers?
 have the audit working papers for issued capital been completed in full and signed by the clerk who compiled them?
 has sufficient audit evidence been obtained during the performance of the audit procedures in substation of the
“assertions” as applicable to issued capital?
 were remarks made regarding the audit of issued capital which need further attention?
 what conclusion is reached after the audit of issued capital?

Provisions, contingent liabilities and contingent assets

Companies should make adjustments for anticipated events (provision) or at least disclose them (contingent liability)
Provision examples :
 cleaning up of environmental damage
 provision for refunds to dissatisfied customers recognised as liability in BS if can be measured reliably
 provision for damages arising from a court case.
Contingent liability is not as “certain” as provision and are only disclosed in the notes.

So provision = liability of uncertain timing or amount. Recognised when :

 entity has present obligation cos of past event
 its probable that an outflow of resources will be needed to settle the obligation
 reliability estimated can be made of the amount of the obligation
If these conditions aren’t met then can’t recognise the provision, but can still disclose it as contingent liability in the notes.
Auditor must ensure that the GL account assertions are :
 completeness – all provisions are included in account balance
 existence – all provisions are not fictitious
 valuation – all provisions are included at appropriate amount
 obligation – provisions represent an obligation of the entity
Must also be appropriately presented and described in BS & IS and disclosures in notes must be clearly expressed,
accurate and understandable.

Contingent liability = possible obligation arising from past events, existence of which will only be confirmed by occurrence
or non-occurrence of uncertain future event not completely in control of entity.
Not recognised in financial but must be disclosed as note in BS and assertions for the note are :
 completeness – all contingent liabilities are included in the notes
 obligation – contingent liabilities disclosed all pertain to the entity
 occurrence – event giving rise to the contingent liability has actually occurred (not fictitious)
 understandability – disclosures are appropriately described and clearly expressed
 valuation and accuracy – information provided in the disclosure is fair and accurate and the values included are
appropriate.

Audit procedures for provisions and contingent liabilities :

 existence :
 evaluate companies procedures for identifying provisions and contingent liabilities
 inspect supporting documentation for each provision and evaluation if there is a legal or constructive present
obligation from past event that will result in payment or outflow of resources to settle the obligation and evaluation
the basis on which the amount of the obligation was determined (to check if reliable estimate was made)
 consider process used to authorise the recognition / disclosure (e.g. minuted by the Board would prove is real)
 discuss uncertainties or concerns with the directors
 seek legal or expert advise if necessary ()e.g. for environment damage provision)
 valuation – basically auditing an estimation ISA 540 says auditor should :
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 review and test process that management used to develop estimate (approval / authorisation procedure)
 evaluate data on which the estimate is based for accuracy, completeness and relevance
 evaluate reasonableness and consistency of any assumptions used in developing the estimate (in light of actual
prior performance or consistent with assumptions used for other similar estimates)
 reperform any calculations pertaining to the estimate
 if auditors estimate or estimate from independent estimate from expert differs greatly from client’s, then must
discuss with management and resolve if possible
 obligation – unlikely that company will include provision or contingent liability in not necessary
 completeness – most significant risk cos company may try to understate the provisions (and material intentional
understatement by directors is fraudulent financial reporting). Auditor must :
 evaluate company’s process and procedures for identifying need for provisions
 compare schedule of provisions and current liabilities for current year to that of prior year and investigate
differences
 inquire from legal advisers if the company is involved in any disputes / legal action and ask for details of probably or
possible losses from these actions and also the legal costs involved
 inspect minutes of directors and shareholders meetings for evidence of the need for provisions such as warrantee
claims, guarantees, environmental damage, refund policies etc
 inspect correspondence and returns for SARS taxation matters
 inspect cash payments after year-end for unusual material payments and follow up
 obtain confirmation certificate from company’s bankers detailing guarantees for loan and discounted bills etc
 discuss the completeness of the provisions with management and request specific references to provisions
 presentation and disclosure – auditor must ensure :
 are complete in terms of 4th schedule and IAS’s :
 carrying amounts of provisions at the beginning and end of the period
 additional provisions made and increases to existing provisions
 unused amounts are reversed
 brief description of the nature of the obligation and the expected timing of any resulting outflows
 brief description of each contingent liability and an estimate of its financial effect
 are consistent with evidence gathered on the audit
 amounts, facts, details etc are accurate and agree with the gathered evidence
 classification of the information is appropriate
 working of the disclosure is clear and understandable

Contingent asset – possible asset arising from past event and asset’s existence will only be confirmed by occurrence or
non-occurrence of an uncertain future event not completely in control of the entity (e.g. successful outcome of a court case).
Must be disclosed in notes if there is a probably inflow of economic benefits to the entity.

Commitments – entity must disclose any commitments for things like capital expenditure etc