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Audit procedures for Balance Sheet items: [Link]

procedures
When you have completed this article you will be able to: (1) Explain the assertions contained in the
financial statements; (2) Provide examples of procedures used to audit specific balances; (3) Discuss
and provide examples of how analytical procedures are used as substantive procedures; (4) Apply
audit techniques to small and not-for-profit organisations; and (5) Discuss the problems associated
with the audit and review of accounting estimates.

General principles: We dealt with the principles of audit evidence earlier. This article deals with
the application of those principles. It is a starting point to help you familiarise yourself with the basic
auditing techniques to allow you to apply them to questions. It is not an exhaustive summary of all
audit tests, this would simply not be possible in one volume. Financial statement assertions: The
objective of audit testing is to assist the auditor in coming to a conclusion as to whether the
financial statements are free from material misstatement. However, the auditor does not simply
design tests with the broad objective to identify material misstatements. This is a difficult
conclusion to reach and can only be based upon a series of detailed tests, each designed with a
specific testing objective relating to certain areas of the financial statements. For example: auditors
have to assess whether inventory balances are free from material misstatement. Unfortunately,
there are many ways inventory could be misstated: (1) items could be omitted from inventory; (2)
items from the next accounting period could be accidentally included; (3) it might not be valued at
the lower of cost and net realisable value; (4) damaged or obsolete stock might not be identified; (5)
purchase cost may not be recorded accurately; or (6) the stock count may not be performed
thoroughly. Each of these concerns could result in misstatement, which ultimately could (alone or in
aggregate) be material. For this reason, auditors have to perform a range of tests on the significant
classes of transaction, account balances and disclosures to be reasonably sure that they are not
misstated. These tests focus on what are known as financial statement assertions: (1)
Occurrence: did the transactions and events recorded actually occur and pertain to the entity? (2)
Completeness: have all transactions, assets, liabilities and equity interests been recorded that
should have been recorded? (3) Accuracy: have amounts, data and other information been
recorded and disclosed appropriately? (4) Cut-off: have transactions and events been recorded in
the correct accounting period? (5) Classification and understandability: have transactions and
events been recorded in the proper accounts and described and disclosed clearly? (6) Existence:
do assets, liabilities and equity interests actually exist? (7) Rights and obligations: does the entity
hold or control the rights to assets and are liabilities real obligations of the entity? (8) Valuation
and allocation: are assets, liabilities and equity interests included in the financial statements at
appropriate values?
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Linking assertions to tests: When the auditor designs further audit procedures they must ensure
that they test a range of the assertions listed. For transactions (i.e. incomes and expenses
recorded in the income statement) the auditor should test: (1) occurrence; (2) completeness; (3)
accuracy; (4) cut-off; and (5) classification
For account balances (i.e. those balances recorded on the statement of financial position) the
auditor should test: (1) existence; (2) rights and obligations; (3) completeness; and (4) valuation and
allocation. Whilst the testing of accounts balances and transactions will probably be the focus of the
audit, the auditor must also design tests to ensure that transactions, balances and other relevant
information/matters are appropriately disclosed in the financial statements. Assertions relevant to
the disclosures are: (1) occurrence; (2) rights and obligations; (3) completeness; (4) classification
and understandability; and (5) accuracy and valuation. To assist your studies and simplify this
process consider the following four questions that an auditor needs to answer when approaching
testing: (1) Should items be in the accounts at all? (occurrence, existence, rights and obligations,
cut-off). (2) Are they included at the right value? (accuracy, valuation). (3) Are there any more?
(completeness). (4) Are they disclosed properly? (classification, allocation, understandability). In the
sections that follow, we will consider specific audit areas and suggest how these are usually tested.
You may be tempted to learn these tests and repeat them 'parrot fashion' in the exam. This would
be unwise. Audit procedures are designed to reflect the unique risks of an audit and the nature of
items and assertions under scrutiny. You must always try and make your answers specific to any
scenarios presented in the exam. This requires both knowledge and application skills.
The audit of receivables The audit of inventories

Key assertions: (1) Existence: do the receivables actually exists? (2) Rights and obligations:
does the company have the right to receive the amount indicated in receivables; (3) Valuation and
allocation: are receivables included in the financial statements at the correct amount, including
provisions for bad and doubtful debt; (4) Completeness: have all receivables as at the year-end
been accounted for; and (5) Classification and understandability: are receivables (including
provisions) appropriately disclosed in the financial statements.
Audit procedures: (1) Existence: (a) Perform a receivables circularisation (a direct confirmation
from external sources - see below). (b) Select a sample of receivables and trace amounts due to the
original sales invoice to confirm that a transaction has taken place; (2) Rights and obligations: (a)
Receivables circularisation; (b) Select a sample of receivables and confirm the trade terms to original
credit agreements and sales invoices. (3) Valuation and allocation: (a) Inspect the ageing profile of
receivables to identify any significant, long outstanding balances that may require a provision. (b)
Analytically review the ageing profile in comparison to previous periods to identify any deterioration in
credit control. (c) Inspect post year-end cash book/bank statements and trace payments received to
year-end receivables to confirm that amounts were indeed collectable. (d) Discuss the results of the
ageing and cash receipts analysis with management to identify if any further provisions are required for
old, unpaid balances. (e) Discuss the assumptions underlying any general provisions with management
to ensure they are appropriate. (f) Recalculate the provision based on management’s assumptions and
agree to the figure in the financial statements. (g) Inspect invoices relating to prepaid balances, agree
cost to calculations made. (h) Inspect bank statements to confirm prepaid amounts have been paid. (4)
Completeness: (a) Obtain a list of receivables balances, cast this and agree it to the receivables
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control account total at the end of the year. Differences should be reconciled. (b) Perform a receivables
circularisation. (c) Inspect receivables ledger for credit balances and obtain explanations from
management. (d) Inspect a sample of the last five to ten goods despatched notes immediately prior to
the year-end. Trace these through to year-end receivables to ensure they have been recorded. (5)
Classification and understandability: (a) Inspect the draft financial statements and agree the
receivables figures and disclosures to nominal ledger balances. Also note the effect of directional
testing, e.g. directly testing receivables for overstatement also indirectly tests revenue for
understatement (Dr: Receivables, Cr: Revenue).
Receivables circularisation: If successful, circularisations provide evidence directly from the
receivables themselves. These are considered to be reliable because they are external, third party
confirmations. Circularisations are also written and original. Procedure: (1) Select a sample of
receivables to be circularised and notify the client of those selected; (2) Extract details of each
receivable from the relevant ledger and prepare letters. These should state the balance outstanding
at the year-end and include a reply slip for receivables to confirm the balance; (3) Ask the chief
accountant at the client (or other responsible official) to sign the letters; (4) The auditor posts or faxes
the letters to the individual receivables; (5) The receivables complete the reply slips, confirming the
amounts they owe the client at the year-end, and post them directly to the auditor; and (6) The
auditor investigates any disagreement by receivables.
Considerations: Whilst circularisations are undoubtedly a useful and efficient tool for providing
good quality evidence, their success does depend on response rates. It must be remembered that
the audit client's customers are under no obligation to reply and, for this reason, responses may be
limited. If the response rate is poor then other forms of evidence must be sought. To maximise the
response rate auditors should ensure: (1) Letters are sent out as soon as possible after the year-
end; (2) That the outstanding balance is clearly displayed and all that receivables have to do is
confirm whether this is correct or not; (3) A reply slip is attached to minimise the work of the
receivable; and (4) Pre-paid return envelopes are supplied.
Example confirmation letter
Customer Ltd
Customer’s address
Date of circularisation
Dear Sirs,
As part of their normal audit procedures we have been requested by our auditors, Auditor & Co, to
ask you to confirm the balance on your account with us at 31 December 2023, our year-end. The
balance on your account, as shown by our records, is shown below. After comparing this with your
records, please be kind enough to sign the confirmation slip and return a copy to the auditor in the
prepaid envelope enclosed. If the balance is not in agreement with your records, will you please
note the items making up the difference in the space provided. Please note that this request is made
for audit purposes only and has no further significance. Your kind co-operation in this matter will be
greatly appreciated.
Yours faithfully

Auditor & Co
Auditor’s address
Dear Sirs
We confirm that, except as noted below, a balance of KShs 1 million was owing by us to Client
Limited at 31 December 2024. (space for customer's signature) Details of differences:
…………………………………………………………………..
The audit of inventories: Key assertions: (1) Existence: does the inventory recorded actually
exist? (2) Completeness: have all inventory balances been recorded? (3) Rights and obligations:
does the company have the right to receive the benefits from inventories? (4) Valuation and
allocation: are inventories valued appropriately (i.e. at the lower of cost and net realisable value
and net of any provisions for damaged and slow moving goods)? (5) Cut-off: are inventory
movements around the year-end recorded in the correct period? (6) Classification and
understandability: are inventories (including provisions) appropriately disclosed in the financial
statements?
The inventory count: Principles: (1) A typical inventory count happens the day after the year-
end, although continuous counting is possible throughout the year. (2) The purpose of the count is
to confirm that the quantities of inventory recorded on the client's system are accurate. (3) Whilst
the count is being performed items that are damaged and/or obsolete should be identified for either
scrapping or sale at a discounted price. (4) From an audit perspective, attendance at the count
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helps provide evidence regarding the existence, completeness and valuation of inventory
balances. (5) Inventory counting is the responsibility of the client. The auditor merely attends the
count to help gather evidence to form an opinion regarding whether inventory is free from material
misstatement or not.
Inventory counting procedures: Before the count: Obtain the client's counting instructions and
review them for obvious flaws in the counting process. This may also help identify if there are any
significant or risky elements of inventory that require special attention, or even precautions.
During the count: (1) Observe the count as it proceeds to ensure: (a) the counting instructions
are being followed; (b) all items are being counted and recorded; (c) double counting is avoided; (d)
evidence of damaged or slow moving goods is being recorded; (e) deliveries and despatches are not
being made during the count; (f) count recording sheets are being properly controlled (i.e. pre-
numbered and filled in with ink). (2) Conduct test counts, on a suitable sample selection basis, as
follows: (a) select a sample of items from the inventory records and physically observe the items on
the warehouse floor to prove the items exist. (b) select a sample of physical items from the
warehouse floor and trace them to the inventory records to ensure that the latter is complete. (3)
Record cut-off information by obtaining details of the last deliveries and despatches prior to the
year-end. These will then be traced to inventory records during final audit procedures.
Continuous inventory systems: The procedures suggested above apply to all inventory counts,
whether as a one-off, year-end exercise or where inventory is counted on a rolling basis throughout
the year. The objective is the same: (1) To identify whether the client's inventory system reliably
records, measures and reports inventory balances.
Where the client uses a continuous counting system, lines of inventory are counted periodically (say
monthly) throughout the year so that by the end of the year all lines have been reviewed. There are
both advantages and disadvantages of this for the auditor. Advantages: (1) The auditor is less time
constrained and can pick and choose particular locations and inventory lines to count at any time to
ensure the system is reliable. (2) Slow moving and damaged inventory should be identified and
adjusted for in the client's records on a continuous basis, thus improving the valuation at the year-
end. Disadvantages: (1) The auditor will need to gain sufficient evidence that the system operates
effectively at all times, not just at the time of the count. (2) Additional procedures will need to be
devised to ensure that the year-end inventory total is reliable, particularly with regard to cut-off and
year-end provisions/ estimates. Inventory held at third parties: (1) Where the client has inventory
at locations not visited by the auditor, the auditor normally obtains confirmation of the quantities,
value and condition from the holder. The auditor needs to consider whether the holder is sufficiently
independent to be able to provide relevant, reliable evidence. (2) As with confirmations from
receivables, the auditor requests details from the party holding the inventory on behalf of the client to
confirm its existence. (3) The confirmation request will be sent by the client to those parties identified
by the auditor. (4) The reply should be sent directly to the auditor to prevent it being tampered with
by the client. (5) Problems can occur if the third party uses a different description to that of the client
and as always, a response is not guaranteed.
Final audit procedures: Completeness: (1) Obtain an inventory list showing each line of
inventory categorised between finished goods, WIP and raw materials. Cast the list to ensure it is
arithmetically correct. Make sure the totals agree to amounts disclosed in the financial statements.
(2) Trace the items counted during the inventory count to the final inventory list to ensure it is the
same as the one used at the year-end and to ensure that any errors identified during counting
procedures have been rectified. Cut-off: (1) Trace the Goods Received Notes (GRNs) from
immediately prior to the year-end (identified during the count) to year-end payables and inventory
balances. (2) Trace the Goods Delivery Notes (GDNs) from immediately prior to the year-end
(identified during the count) to the nominal ledgers to ensure the items were removed from
inventory prior to the year-end and have been recorded in receivables prior to the year-end.
Presentation and disclosure: (1) Inspect the financial statements and ensure that the figures
disclosed agree to the audited nominal ledger balances and that inventories have been correctly
analysed between finished goods, raw materials and work in progress. Valuation: (1) Trace a
sample of inventory items back to original purchase invoices to agree their cost. (2) Trace a sample
of inventory items to post-year-end sales invoices to determine if the appropriate cost or net
realisable value has been used. (3) Inspect the ageing of inventory items to identify any old/slow
moving amounts that may require provision. (4) Trace the above items to any inventory provisions
and, if they have not been provided, discuss the reason with management. (5) Recalculation of work
in progress and finished goods using payroll records for labour costs and utility bills for overhead
absorption. (6) Calculate inventory turnover/days and compare to the previous year to assess
whether inventory is being held longer and therefore requires greater provisions. (7) Calculate the
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gross profit percentage and compare to the prior year figure to identify any significant fluctuations
that may indicate either error or changes in inventory holding policies.
The audit of payables, accruals, provisions and contingent liabilities: Key assertions: (1)
Existence: do the payables actually exist? (2) Rights and obligations: does the company have the
obligations to settle all payables? (3) Valuation and allocation: are payables are included in the
financial statements at the correct amount? (4) Completeness: do all payables relate to the period
have been accounted for? (5) Classification and understandability: are all payables are
appropriately disclosed in the financial statements? Completeness is usually the key consideration
when testing payables due to the timing and nature of the items included. Provisions and accruals
accounting do offer an opportunity for creative accounting to manipulate reported profits. Auditors
therefore have to consider indicators that additional liabilities may exist, such as: (1) payables not
including known major suppliers and those accrued for in the prior year; (2) payables not including
the significant suppliers from the equivalent list last year; (3) traditionally recurring accruals not
being made, e.g.: rent, utilities, telephone, etc. (4) expected finance accruals not being made, e.g.:
hire purchase, mortgages, loans etc. (5) non-provision of tax balances, including: corporation tax,
PAYE, VAT, NHIF, NSSF, etc. (6) suppliers revealed only after a review of payments after the year-
end; and (7) suppliers revealed by a review of unpaid invoices at and after the year-end.
Classification and understandability: Inspect the financial statements to ensure that all liabilities
from the nominal ledger have been adequately and accurately disclosed. Existence: (1) Circularise a
sample of trade payables to confirm the balance at the end of the year (this is uncommon and would
only be performed in the absence of supplier statements). (2) Inspect year-end statements of accounts
sent by suppliers. Any differences between the statement and the nominal ledger should be
reconciled. (3) Trace a sample of payable/accruals balances to purchase invoices and/or contracts. In
particular identify the date of receipt of the invoice and any evidence of payment (such as signatures).
Completeness (1) Cast the payables ledger to ensure its accuracy. (2) Inspect year-end statements
of accounts sent by suppliers. Any differences between the statement and the nominal ledger should
be reconciled. (3) Investigate any major (by value of purchases in the year) or known regular
suppliers that were shown on last year's payables listing but do not have a balance showing in this
year's list of balances. Enquire of management why these suppliers do not feature in this year's
payables list. (4) Inspect after date payments in the cash book and bank statements and ensure they
have been provided for at the year-end, as appropriate. (5) Perform analytical procedures on the list
of payables, such as: (a) payables days, payables as a percentage of purchases, monthly payables
levels. Investigate any unusual variances. (b) Compare the purchase ledger control account to the list
of payables. Reconcile any variations. (c) Inspect the list of balances for debit balances. Discuss
results with management. Cut-off: (1) Select a sample of GRNs raised immediately prior to the year-
end and trace them through to year-end payables. (2) Likewise, select a sample of GRNs raised
immediately after the year-end and trace them to the nominal ledger to ensure they have been
recorded in the following accounting period. Again, note the effect of directional testing, e.g. directly
testing payables for understatement also indirectly tests expenses/cost of sales for understatement
(Dr: Expenses/Cost of sales, Cr: Payables). Supplier statements: Companies may send out monthly
statements of account as part of their credit control procedures. It is likely that audit clients will
receive a number of these statements from suppliers at the year-end. These can be reconciled to their
own payables accounts to ensure that their records are correct. This is known as a supplier statement
reconciliation and is an important source of audit evidence. Like most statements sent through the
post there are a number of reasons why there may be variances: (1) Timing differences: (a)
Invoices sent by the supplier but not yet received by the client. (b) Payments sent by the client but not
yet received by the supplier. (c) Returns and credit notes not yet appearing on the supplier’s
statement. (2) Errors: (a) Supplier errors that will remain as part of the reconciliation until the
supplier corrects them. (b) Client errors, which the client needs to adjust. Auditors can inspect or
reperform the supplier statement reconciliations to ensure the completeness, existence and valuation
of payable balances. They are a reliable source of evidence because they are produced by the
suppliers, who are (usually) independent, external sources (but note suppliers may be related
parties/intergroup companies, and therefore not independent). Accruals: (1) Inspect invoices
received after the year-end that relate to services provided before the year-end. Trace them to any
accruals made to ensure completeness and accuracy of the amounts. (2) Obtain the list of accruals
from the client, cast it to confirm arithmetical accuracy. (3) Agree the figure per the schedule to the
general/nominal ledger and financial statements. (4) Recalculate a sample of accrued costs by
reference to contracts and payment schedules (e.g. loan interest). (5) Analytically review in
comparison to previous period to try and identify if any balances are perhaps missing. Tax balances:
Corporate tax: agree to tax computed and ensure instalments were paid in accordance with the
Income Tax Act; Pay as you earn (PAYE) tax: ensure PAYE throughout the year was paid on or
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before the ninth (9th) day of the following month; check that PAYE for the final month agrees with the
payroll total; Value added tax (VAT): check that the amount in the financial statements agrees with
the VAT return for the final month; National Social Security Fund (NSSF) and National Health
Insurance Fund (NHIF): check that the amounts due for the final month agree with the payroll.
Overdrafts, etc: Agree to bank letter confirmation of outstanding amounts. Leases, hire purchase:
Agree details to underlying agreement/contracts and recalculate interest amounts and the split
between current and non-current liability: Loan payables: (1) Agree the year-end loan balance to any
available loan statements to confirm obligations, existence and valuation. (2) Agree interest payments
to the loan agreement and the bank statements. (3) Analyse relevant disclosures of interest rates,
amounts due (e.g. between current and non-current payables) to ensure complete and accurate. (4)
Recalculate the interest accrual to ensure arithmetical accuracy. Provisions and contingencies: (1)
Provisions are a form of payable where the amount or timing of payment is uncertain. As such they
are harder to audit. Where the likelihood of payment is only possible, rather than probable, no
amounts will be entered in the accounts. However, the matter (contingent liability) must be
adequately disclosed. (2) Discuss the matter giving rise to the provision with the client to verify
whether an obligation exists. (3) Obtain confirmation from the clients’ lawyers as to the possible
outcome and probability of having to make a payment. (4) Review subsequent events. By the time the
final audit is taking place the matter may have been settled. (5) Obtain a letter of representation from
the client as the matter is one of judgement and uncertainty. (6) Recalculate the provision if possible,
e.g. warranty provisions for repairs.
The audit of bank and cash: Key assertions: (1) Existence: do cash and bank balances actually
exist? (2) Rights and obligations: does the company have rights to receive the benefit from those
balances? (3) Valuation and allocation: are balances included in the financial statements at the
correct amount? (4) Completeness: have all balances have been accounted for? (5) Classification
and understandability: are balances are appropriately disclosed in the financial statements? The
bank letter: (1) This is a direct confirmation of bank balances from the bank that gives the auditor
independent, third-party evidence. (2) The format of the letter is usually standard and agreed
between the banking and auditing professions. (3) Issues covered are: (a) the client’s name; (b) the
confirmation date; (c) balances on all bank accounts held; (d) any documents or other assets held for
safekeeping; (e) details of any security given by the client e.g. land and buildings; (f) details of any
contingent arrangements: i.e. guarantees, forward currency purchases or sales, letters of credit. (4)
The auditor needs the client to give the bank authorisation to disclose the necessary information (in
some jurisdictions such disclosures are illegal so bank letters cannot be used at all). (5) Ensure that
all banks that the client deals with are circularised. (6) The balances for each account should be
agreed to the relevant bank reconciliation at the year-end; (7) Details of loans should be agreed to the
disclosure in the statement of financial position as either current or non-current. Example bank
confirmation letter:
Kalamu House, Grevillea Grove,
Off Brookside Drive, Westlands
PO Box 14077-00800, Nairobi
To: Manager (Audit confirmations)
NCBA Bank Limited
PO Box 44599-00100
Nairobi Kenya
15 January 2024
Dear Sir,
In accordance with the agreed practice for provision of information to auditors, please forward
information on all Isuzu EA Ltd accounts with you, as detailed below, to us PKF.
Company name: Isuzu East Africa Limited: Main account number: 01789311: Sort code: 4-83-12;
Information required: (1) Balance on all accounts; (2) Any trade finance entered into; (3) Custodian
arrangements; (4) Other information (see attached): Audit confirmation date: 31/12/2023: The
Authority to Disclose Information signed by us is already held by you. This is dated 30/08/2013.
Please advise us if this Authority is insufficient for you to provide full disclosure of the information
requested.
The contact name is: Asif Chaudry (Audit Partner): Telephone: +254 0722 596 750
Yours faithfully, PKF.
Bank and cash: other evidence: (1) Obtain a list of all bank accounts, cash balances and bank loans
and overdrafts and agree to items making up the totals to figures included in current assets and
current liabilities in the financial statements. (2) Obtain a copy of the client's bank reconciliation,
cast and agree the balances to the cash book and bank letter.
Example bank reconciliation: Bank reconciliation as at 31 December 2023
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Balance as per bank statement Kes 1,692,437

Deduct: Cheques not yet presented (itemize) (213.684)
Deposits not shown on bank statement subsequently shown 196,400
Balance as per cash book 1,675,153
(3) Trace all outstanding lodgements and unpresented cheques to pre-year-end cash book and post-
year-end bank statements. (4) Ensure all accounts in the bank letter are included in the financial
statements. (5) Ensure bank loans and overdrafts are not offset against positive bank balances in
the financial statements –unless the right to do so is contained in a letter signed by the bank. (6)
Count the petty cash in the cash box at the end of the year and agree the total to the balance
included in the financial statements. Presentation and disclosure: Inspect the draft financial
statements and ensure that amounts are disclosed correctly as either assets (positive balances) or
liabilities (overdrafts) and that the amounts recorded agree to the nominal ledger.
The audit of payables, accruals, provisions and contingent liabilities The audit
of bank and cash

The audit of tangible non-current assets: Key assertions: (1) Existence: do the assets actually
exist? (2) Rights and obligations: does the company have rights to receive the benefit from those
assets? (3) Valuation and allocation: are assets included in the financial statements at the correct
amount; (4) Completeness: have all assets have been accounted for. (5) Classification and
understandability: are assets appropriately disclosed in the financial statements?
Existence: Select a sample of assets from the non-current asset register and physically inspect them.
Completeness: (1) Select a sample of assets visible at the client premises and inspect the asset
register to ensure they are included. (2) Examine the repairs and maintenance accounts in the general
ledger for large and unusual items that may be capital in nature. These should be included in the
statement of financial position, not expenses. Valuation: (1) Cast the non-current asset register to
ensure arithmetical accuracy. (2) Recalculate the depreciation charge for a sample of assets. (3)
Analytically review depreciation charges in comparison to the prior year. (4) Perform a proof in total by
adjusting the prior year figure for all additions, disposals and revaluations and then calculating total
depreciation based upon this figure. (5) Compare depreciation methods and policies in comparison to
the previous year to ensure consistency. (6) If any assets have been revalued during the year: (a) agree
new valuation to valuer’s report; (b) verify that all assets in the same class have been revalued; (c) re-
perform depreciation calculation to verify that charge is based on new carrying value. (6) When
physically inspecting assets, take note of their condition and usage in caseimpairment. (7) For a sample
of asset additions, agree the cost to purchase invoices (or other relevant documentation). (8) If any
assets have been constructed by the company, obtain analysis of costs incurred and agree to supporting
documentation (timesheets, materials invoices, etc.).
Rights and obligations: (1) For a sample of recorded assets, obtain and inspect ownership
documentation: (a) title deeds for properties; (b) registration documents for vehicles; (c) insurance
documents may also help to verify ownership (and asset values). (2) Where assets are leased,
inspect the lease document to assess whether the lease is operating or finance and accounted for as
a right of use asset or an owned asset. Disclosure: (1) Agree opening balances with prior year
financial statements. (2) Compare depreciation rates in use with those disclosed. (3) For revalued
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assets, ensure appropriate disclosures made (e.g. name of valuer, revaluation policy). (4) Agree
breakdown of assets between classes with the general ledger account totals.
The audit of tangible non-current assets The audit of share capital, reserves and
directors' remuneration

The audit of share capital, reserves and directors' remuneration: Directors' remuneration is a
key audit area as it is invariably material by nature. Key assertions: (1) Existence: do share capital
balances and reserves actually exist? (2) Rights and obligations: does the company have obligations
regarding equity balances? (3) Valuation and allocation: is equity included in the financial statements
at the correct amount? (4) Completeness: have all equity balances, directors' remuneration and other
transactions with directors been accounted for. (5) Classification and understandability: have
relevant disclosures been made in the financial statements, particularly with regard to directors'
remuneration. Share capital: (1) Agree authorised share capital and nominal value disclosures to
underlying shareholding agreements, such as company memorandums, articles of association and lists
of registered members; (2) Inspect cash book for evidence of cash receipts from share issues; (3)
Inspect terms of share certificates and reconcile to cash receipts and new share capital totals; (4)
Inspect board minutes to identify if any dividends have been declared prior to the year-end or proposed.
Directors' remuneration: (1) Reconcile reported directors' salaries to payroll records; (2) Inspect
board minutes for evidence of directors' bonus announcements; (3) Reconcile directors' bonuses to cash
payments in the cash book; (4) Inspect board minutes for approval of related party transactions; (5)
Obtain a written representation from directors that they have disclosed all related party transactions
and director remunerations to the auditor. Reserves: (1) Reconcile closing profit reserves to: opening
reserves, profit for the year and dividend paid and proposed during the year; (2) Compare opening
reserves to closing reserves reported in the prior year's financial statements; (3) Reconcile movements
in revaluation reserves to the non-current asset register; (4) Corroborate revaluations by comparing to
independently produced reports.
Accounting estimates: Accounting estimates are of particular concern to the auditor as, by their
nature, there may not be any physical evidence to support them and they are prone to inaccuracy. They
are also subjective and therefore prone to management bias. If the directors wished to manipulate the
accounts in any way, accounting estimates are an easy way for them to do this. The auditor must take
care when auditing estimates to ensure this has not been the case. In accordance with ISA
540 Auditing Accounting Estimates, auditors need to obtain an understanding of: (1) How management
identifies those transactions, events and conditions that give rise to the need for estimates; and (2) How
management actually makes the estimates, including the control procedures in place to minimise the
risk of misstatement. ISA 540 also requires the auditor to: (1) Evaluate the degree of uncertainty
associated with an accounting estimate; and (2) Consider if estimates with a high degree of uncertainty
give rise to significant risks. In response to this assessment, auditors should perform the following
further procedures: (1) Review of the outcome of the estimates made in the prior period (or their
subsequent re-estimation); (2) Consider events after the reporting date that provide additional evidence
about estimates made at the year-end; (3) Test the basis and data upon which management made the
estimate (e.g. review mathematical methods); (4) Test the operating effectiveness of controls over how
estimates are made; (5) Develop an independent estimate to use as a point of comparison; and (6)
Consider whether specialist skills/knowledge are required (e.g. a lawyer).
Accounting estimates Smaller entities
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Smaller commercial entities will usually have the above attributes. This can lead to both advantages
and disadvantages:
(1)Lower risk: Smaller entities may be engaged in activity that is relatively simple and therefore lower
risk. However, this will not be true for small one person businesses where there is a high level of
expertise in a particular field, e.g. consultancy businesses, creative businesses, the financial sector. (2)
Direct control by owner managers is a strength because they may know what is going on and have
the ability to exercise real control. They are also in a strong position to manipulate the figures or put
private transactions through the books. (3) Simpler systems: Smaller entities are less likely to have
sophisticated IT systems, but pure, manual systems are becoming increasingly rare. This is good news
in that many of the bookkeeping errors associated with smaller entities may now be less prevalent.
However, a system is only as good as the person operating it. Evidence implications: (1) The normal
rules concerning the relationship between risk and the quality and quantity of evidence apply
irrespective of the size of the entity. (2) The quantity of evidence may well be less than for a larger
organisation. (3) It may be more efficient to carry out 100% testing in a smaller organisation.
Problems: (1) Management override: Smaller entities will have a key director or manager who will
have significant power and authority. This could mean that controls are lacking in the first place or they
are easy to override. (2) No segregation of duties: Smaller entities tend to have few members of staff
that processes information. To overcome this the directors should authorise and review the all work
performed. (3) Less formal approach: Smaller entities tend to have simple systems and very few
controls due to the trust and the lack of complexity. It is therefore difficult to test the reliability of
systems and substantive testing tends to be used more.
Not-for-profit organisations: Not for profit (NFP) organisations include charities and public sector
entities. The most important differences from privately owned companies are that NFP entities: (1) do
not have profit maximisation as their main objective. These will be either social or philanthropic; (2) do
not have external shareholders; and (3) do not distribute dividends. Potential problems auditing a
NFP entity: Some NFP entities, particularly small charities, may have weaker systems due to: (1) lack
of segregation of duties, as the organisation will be restricted with the number of members of staff; (2)
the use of volunteers, who are likely to be unqualified and have little awareness of the importance of
controls; (3) the use of less formalised systems and controls. Significantly, with many charities, much of
the income received is by way of donation. These transactions will not be accompanied by invoices,
orders or despatch notes. Assessing the going concern of a NFP entity may also be more difficult,
particularly for charities who are reliant on voluntary donations. Many issues, such as the state of the
economy, could impact on their ability to generate revenue in the short term. Audit implications:
Auditors of not for profit organisations will be required to assess whether the aims of the organisation
are being met in an economic, efficient and effective manner. For this reason, "value for money" audits
are much more appropriate. Testing tends to concentrate on substantive procedures where control
systems are lacking. In the absence of documentary evidence procedures rely heavily on analytical
review, enquiry and management representation. The volumes of transactions in not for profit
organisations may be lower than a private one, therefore auditors may be able to test a larger % of
transactions. Ultimately, if sufficient appropriate evidence is not available the auditor will have to
modify their audit report.