Specific items in the financial

statements
Some of the specific items in financial statements that are regularly tested by auditors are:

1. Receivables

2. Inventory

3. Payables and accruals

4. Loans, bank and cash

5. Tangible and intangible non-current assets

6. Provisions and contingencies

7. Share capital, reserves and directors’ remuneration

1. Receivables

Risks relating to receivables

Auditors need to consider the following areas of general risk in the audit of receivables,
including prepayments, and sales.

Accounts receivable may not be recoverable if:

• overdue;
• liquidated/in receivership;
• disputed (e.g. overpricing/goods supplied).

An accounts receivable analysis may not accurately reflect the age of debts, for example
if items are not matched in an ‘open-item’ system.

Trade receivables will be overstated if:

• sales are overstated;
• fictitious balances are reported; or
• the estimate for irrecoverable and doubtful debts is inadequate.

‘Teeming and lading’

Receipts are pocketed and banking delayed until another receipt makes up the shortfall.
The misappropriation is disguised by incorrect posting of subsequent cash receipts,
fictitious credit notes or an irrecoverable debt write-off (this is also called ‘lapping’). A
misappropriation is only concealed when allocations match amounts of receipts;
otherwise customers having made the payments would be ‘put upon enquiry’.

Prepayments
Prepayments may not be recognised and correctly accounted for, resulting in:
• an overstatement of expenses charged to the profit and loss; and the
• an understatement of prepayments on the statement of financial position.

In most entities individual prepayments will not be material, but the cumulative effect
of an inappropriate accounting treatment of all prepayments must be considered as a
risk.
 Sales
The auditor should be aware of and respond to the risk of material misstatement due
to revenue recognition fraud.

Common revenue frauds include:

• early revenue recognition;
• holding the books open past the close of the accounting period;
• fictitious sales; and
• failure to record sales returns.

Revenue may be misstated if the five steps of the revenue recognition process have
not been properly applied.

Audit procedures for receivables

To test the assertions for receivables, auditors should:

• Obtain the list of accounts receivable and agree the total to the general ledger
(completeness).

• Test the adequacy of the allowance for irrecoverable receivables (valuation).

• Review bank confirmations and loan agreements for evidence that receivables have
been used to secure indebtedness (rights).

• Directly confirm a sample of accounts receivable and perform any necessary

alternative procedures (existence).

Prepayments
The most relevant assertions for prepayments are completeness, accuracy, valuation
and allocation, and existence. The auditor should:

• Understand the nature of the business and expected prepayments.

• Obtain a list of prepayments from the client, cast and agree to general ledger
(accuracy, valuation and allocation).

• Compare current prepayments with previous years and, for material items, inspect
supporting evidence such as paid invoices (completeness, existence).

• Identify any unrecorded prepayments by reviewing the cash book for large and
unusual items and inspecting supporting documents such as suppliers’ invoices
(completeness, cut‑off).
 Sales
To test the assertions for sales, auditors should do the following.

• Match a sample of goods received notes (GRNs) to the corresponding sales

invoices and recording in the sales day book (completeness).

• Match a sample of sales transactions from the sales day book to sales invoices,
customer orders and GRNs (occurrence).

• Examine a sample of sales invoices for proper classification into revenue accounts.

• Compare a sample of sales invoices from shortly before and after year-end with the
shipment dates and the dates the sales were recorded (cut‑off).

• Compare prices and terms on a sample of sales invoices with authorised price list
and terms of trade (accuracy).

• For a sample of material contracts with customers, examine the supporting

documentation to determine whether the five steps of the revenue recognition
process were properly applied.

The auditor may also perform the following substantive analytical procedures:

• Compare gross profit percentage by product line with prior years and industry
data.

• Compare reported revenue to budgeted revenue.

• Analyse the ratio of sales in the last month or week to total sales for the year.

• Compare revenues recorded daily for periods shortly before and after the year-end
for unusual fluctuations.

• Compare detail of units shipped with revenue and production records and consider
whether revenues are reasonable compared with levels of production and average
sales price.
2. Inventory

General risks relating to inventory

• Susceptibility to ‘shrinkage’ (e.g. theft by employees or customers).
• Management manipulation of quantities and value.
• Lack of control over quantities: poor recording on receipt, processing and storage.
• Valuation may not be consistent or in accordance with IAS 2.
• Obsolescence (e.g. damage, shelf life, best-before date, change in customer demand).
• Cut-off for inventory movements may be inaccurate.
• Third-party inventory may be included as entity inventory.
• Entity inventory held by third parties may be omitted.

Objectives
• Observe and evaluate compliance with management's instructions in the performance
of the count;
• Inspect the inventory to ascertain its existence and evaluate its condition; and
• Obtain audit evidence (e.g. perform test counts) as to the reliability of management's
count procedures.
Assertions
Audit considerations for the assertions that are specific to inventory include the following:

Completeness • Physical inventory count must be correctly analysed and carried

through to final valuation.
• All inventory movements must be accurately recorded in inventory
control systems for perpetual inventory.
• Completeness (and accuracy) of recorded inventory is affected by
cut-off of sales and purchases transactions.
Accuracy, • Cost method must meet IAS 2 requirements (e.g. inclusion of
Allocation applicable overheads and only FIFO or weighted average cost
and Valuation formulae permitted).
• To determine lower of cost and net realisable value (NRV) requires
identification of inventory that may be damaged or obsolete (e.g.
inspection during physical count, review of expected sales,
understanding commercial environment of client).

Rights • Third-party inventory held by client must be identified and not

(Control) included in year-end valuation.
• Client inventory held by third parties (including that on a ‘sale or
return’ basis) must be verified and included in the year-end
valuation.

Existence The physical inventory count is the main source of audit evidence to
confirm the existence of inventory. If material, inventory held by a third
party may also be inspected.

Key point
Where a material volume of inventory is held by a third party on behalf of the entity
(e.g. provision of warehousing facilities), audit considerations relating to a service
organisation will apply.
Procedures relating to inventory count
The timing of procedures
The procedures that apply equally to end of the reporting period counts and perpetual
inventory counts are:

Before the count Planning

During the count Attendance

After the count Follow-up

Planning
The aim of planning procedures is to identify the risks of material misstatement and
the nature of internal control related to inventory. The auditor should:

• Review the prior-year inventory count working papers to identify potential

problems.

• Contact the client for a copy of the count instructions and agree a date, time, and
location to witness the count.

• Discuss with the client any changes that could affect the audit approach (e.g.
changes in controls, expected volumes, changes in mix (more or less material
items), locations, timing, systems).

• Review the adequacy of the client's instructions.

• Consider the role of and reliance on internal audit, if appropriate.

• Consider arrangements for client's expert and/or auditor's expert if necessary.

• Plan the sampling approach and work programme, and arrange for appropriate
staff to attend the count.
Attendance
On the day of the count, the auditor will generally do the following.

• Attend a briefing meeting.

• Carry out a ‘walk-about’ before start of count to observe the preparations being
carried out, identify material inventory and minimise inventory movement.

• During count, observe that the count instructions are being followed in relation to
count sheets, work-in-progress, counting and completion.

• Carry out test counts, for example:

• from counts already made to the inventory (existence);
• from inventory to a count sheet (completeness);
• from inventory ahead of count team for agreement to count sheet (accuracy)
towards the end of the count (to be effective, the count team should not be
made aware of the items that have been pre-counted by the auditor);
• inspect the contents of boxes and containers, weigh and calculate volumes
(existence).

Key point
The direction of testing (‘sheet to floor’ or ‘floor to sheet’) tests different assertions.

• Discuss with management any discrepancies found in the counts and the action to
be taken (for example corrections by management).

• Collect cut-off information including receipts, despatches, work-in-progress.

• At the end of the count, agree all count sheets are accounted for and copy them
for the final audit visit check that no alterations are made after count – to test the
accuracy, existence, completeness assertions.

• Carry out a ‘walk about’ to ensure that all items that should have been counted are
tagged as having been counted – to test the completeness assertion.
Follow-up (final audit)
The physical count procedures will be followed up during the final audit by:

• Obtaining client's final valuation, summaries and sub-schedules from count sheets.

• Following through any outstanding matters from physical count observation,

including reviewing photocopy of count sheets to client's final sheets to identify
any changes made after the count.
• If changes have been made by the client to the count sheets, their materiality
should be assessed and reasons for the changes ascertained from management
and audited.
• If unsatisfactory (and material), the effect on the auditor's report must be
considered.

• Sampling value calculations (quantity x price) and count sheet castings including
carry forward to summary schedules and final summary (this should be to and from
final summary for understatement and overstatement: completeness and accuracy).

• Sampling raw materials, work-in-progress and finished goods for valuation in

accordance with IAS 2.

• Checking cut-off.

• Carrying out a net realisable value (NRV) review.

• Obtaining written representations concerning the completeness and accuracy of

the physical count and valuation (e.g. NRV).
Inventory held by third parties
Where inventory is held by a third party, apply ISA 402 procedures to confirm existence,
including:
• assessment of controls;
• observation of physical count by third party (if material); and
• confirmation (if immaterial).

If inventory held by third parties is material and physical inspection is not possible,
alternative procedures must be applied to confirm existence, such as:
• independent third party confirmation;
• inspection of insurance certificates;
• post year-end inspection;
• analytical procedures; and
• ‘roll-back’ of production and/or sales after the year-end.

Physical inspection may not be possible when inventory is in sealed containers on board a
boat or held by customs.

Procedures relating to cut-off

To test that an accurate cut-off is established at the physical count date:

• Observe the control over the movement of goods between areas while counting is in
progress. For example, goods delivered by a supplier during the count should be held
in a separate area.

• Select goods received notes (GRNs) for a few days before the count date and confirm
that they’ve been recorded as ‘goods in’ in the inventory records before the count
date. The corresponding goods should be included in the physical count (and the
purchase in trade payables).

• Select GRNs for a few days after the count date and confirm that they’ve been
recorded in the inventory records after the count date.

• Similarly, select goods despatch notes (GDNs) for a few days either side of the count
date and compare them with the relevant inventory records (and vice versa) to ensure
that goods out have been recorded in the correct accounting period.
• Goods out before the count date should have been moved from the premises and
so not included in the physical quantities counted (and the sale in trade
receivables).
• Goods out after the count date should be included in the count.
 Key point
All cut-off tests for inventory, sales, receivables, purchases, payables and cash
should be coordinated.

Procedures relating to valuation

Key point

Inventory is valued at the lower of cost and net realisable value (NRV).

In respect of the valuation, the auditor should:

• Understand the nature of the business and activity during the year to assess any
increase in net realisable value (NRV) risks. Seasonal fashion and electronic consumer
goods are good examples of the need for continuous NRV assessment.

• Review inventory observation working papers for NRV indicators (e.g. damaged
inventory).

• Discuss with management the procedures undertaken to assess NRV.

• Review management reports, sales reports and board minutes for evidence of NRV
risks.

• Review after-date sales and current selling prices of at-risk items.

• Apply suitable analytical procedures (e.g. review inventory turnover to identify at-risk
items.

• In computerised inventory systems, review aged-inventory reports or exception

reports which identify items which have not moved in a specified period.

• Review prior-year NRV inventory movements to provide comparison for likely final
selling prices.
CAATs
Where the inventory system is computerised, CAATs will be an effective and efficient tool
for analysing inventory, for example:
• agreeing inventory counts transfers;
• application of costs;
• calculation of values;
• ageing of inventory;
• analysing after-date sales;
• predicting NRV.
3. Payables and accruals

Procedures

Control accounts
Similar procedures to those for trade receivables should be followed.

External confirmation
External confirmation of amounts due to suppliers may be a standard procedure unless
the risk of material misstatement is minimal and the reconciliation of supplier
statements received by the client (i.e. written, external but indirect) can provide
sufficient reliable evidence.

Where the auditor requires a supplier statement that is not available from the client
(e.g. because the supplier does not send monthly statements to its customers), the
auditor should request a confirmation.

Procedures for sending confirmation letters to suppliers are very similar to those for
the receivables confirmation. The main differences are as follows:
• The key assertion is completeness and the key risk is understatement. To test for
understatement, the source of the payable must be identified (i.e. a purchase on
credit results in a payable). The permanent audit file should have details of the
major suppliers. A purchase turnover analysis will identify the major suppliers who
will be expected to have large payable balances. The year-end payable balances
need to be compared with the prior year and those balances which are materially
lower (e.g. due to unrecorded transactions) selected.
• The sample must be selected from a reciprocal population (e.g. purchases or goods
received notes) and not from the list of payable balances.
• Even if the client receives statements from suppliers each month, a confirmation
request may still be sent to a sample of major suppliers.
• The request should be positive and open (i.e. requesting that the supplier state the
balance) and requesting that the supplier sends a copy of their statement as at the
client’s reporting date.

Where a reply to a confirmation request is not received and a supplier statement as at

the year-end is not available, alternative procedures should be applied. For example:
• Contact the supplier directly by phone and to enquire about the balance.
• Confirm the make-up of the year-end balance from GRN, inventory and purchase
invoices.
• Confirm the post-year-end payment.
Completeness

Suppliers statement reconciliations

Key point
Suppliers' statement reconciliations are the main audit procedure for the
verification of the completeness of trade payables and accrued expenses. It
is essential that reconciling items are properly accounted for.

Balances on returned confirmations should be agreed to the balance on the

corresponding year-end supplier's statement.

Where the statement and/or the confirmation balance does not agree to the
payables balance, identify and audit reconciling items. For example:
• Purchase invoices on supplier's statement that are not included in the ledger a/c
balance.
• Cash payments in the payables ledger a/c that are not on supplier's statement.
• Disputes and errors that are supported by appropriate correspondence. If the
dispute concerns the quality of goods, the auditor will need to consider the
follow-through effect (if any) on inventory NRV and whether it has already been
supplied to customers.

Where purchase invoices on supplier's statement are not included in the ledger
balance:
• Agree the goods received to GRN, purchase invoice received after year-end,
and correct posting.
• If goods were received before the year-end (and ownership is accepted) agree
their inclusion in the year-end inventory and as a year-end accrual. Services
rendered before the year-end should similarly be accrued.
• Confirm any other reason for non-inclusion, for example if the client was
wrongly invoiced, there should be a supplier's credit note on a statement after
the end of the reporting period, which cancels the invoice.

Where cash payments in the payables' ledger are not on the supplier's statement:
• Agree cash in transit to the cash book as paid before year-end.
• Agree with audit work on cash and bank as the payment should be included in
the unpresented items on the year-end bank reconciliation that cleared after
the year-end.
• Confirm payment on next month's supplier's statement.
Unrecorded liabilities
Completeness is also tested through a search for unrecorded liabilities, which
focuses on the following:

Payables control
Agree GRNs before year-end included in inventory, agree to purchase invoice and
posted to payables control (via purchase day book) before year-end.

Agree cash payments posted to the control account before the year-end to cash
book and bank statement as pre-year-end (check to bank reconciliation as
necessary).

Purchases ledger
Agree entries made before the year-end, to the daybook, purchase invoice, GRN,
and as included in year-end inventory.

Invoices received after year-end

Review after-date purchase invoices for evidence of goods/services received
before year-end. If so, agree liability and inventory recognised at the year-end.

Cash payments after year-end

Review after-date cash payments to identify payments which relate to
goods/services received before the year-end. Check to ensure that they are
included as a year-end liability and as inventory.

Payroll starters
Review HR information relating to starters (‘new hires’), agreeing their start date
(from which wage/salary and holiday entitlement will accrue) to supporting
documentation. Confirm their inclusion on the year-end payroll (and calculation of
holiday accrual).

Accruals
Goods/services received but not recorded
The liability for goods and services received just prior to the year-end may not be
recorded until after the year-end when the invoice is received and processed.

The client normally will record such items and provide the auditor with a list of accrued
charges.

As this needs to be tested for understatement (completeness), the auditor must

identify such items and then check to see whether they have been included on the list.

Other audit procedures include:

• Casting the list and agreeing the total posted to the general ledger and financial
statements.
• In combination with the search for unrecorded liabilities, reviewing after-date
invoices and payments. Where these relate to pre-year-end expenses their inclusion
in the year-end balance for payables (or goods/services received but not yet
invoiced accrual) needs to be agreed. If they have not been included, the reason
needs to be discussed with management.

Other accruals
• Determine expected accruals from understanding of the nature of the business.
• Obtain, cast and agree a list of accruals from the client.
• Compare with the prior year for reasonableness (e.g. that the electricity accrual is in
line with inflation and any known increase in activity) and any obvious omissions
(e.g. interest and/or bank charges identified by the bank reconciliation).
• Review the post-year-end purchase invoices and cash payments (as described
previously) to identify potential accruals. Where they are material, the accrual will
need to be calculated and agreed to the year-end schedule.
• Agree the current tax liability for corporation/profits tax to the tax computations
prepared by the client.
• Agree accruals for payroll taxes to payroll records as part of the wages audit.
4. Loans, bank and cash

Assertions for account balances

Audit considerations for the financial statement assertions that are specific to account
balances (i.e. in the statement of financial position) include the following:

Completeness • A bank letter will be required to confirm all balances held (including
overdrafts).
Rights and • Bank letter and other direct confirmation letters should confirm
obligations ownership of cash (rights) and obligations for loans.
Existence • Direct confirmation (bank letter) of balances and other relevant
information from the holding institution (e.g. bank) confirms
existence.
• Physical cash in a cash register/till (in retail trade) can be inspected
and counted (and, similarly, petty cash).
Presentation • Generally loans/overdrafts should not be offset against bank
deposits in the statement of financial position.
• Offset is appropriate only when the company has the legal right to
do so (e.g. as agreed in the bank loan contract).
Classification • Cash and loans should be properly classified in the statement of
financial position as current or non-current.
Assertions for transactions
Considerations of the financial statement assertions that are specific to classes of
transactions (e.g. interest receipts/payments) include the following:

Completeness • A reasonableness test (analytical procedure) may provide sufficient

and evidence to confirm interest receivable/payable (i.e. average
Occurrence deposit/overdraft balance by month × monthly interest rate).
• Balances on significant interest-bearing accounts will need to be
compared with the prior year and differences investigated (e.g. if
balances excluded from current year).

Classification • Most interest payments will be expensed to profit or loss in the

period to which they relate.
• However, some interest expense may be allocated to asset
accounts in accordance with IFRS Standards (e.g. interest on a loan
obtained to finance the construction of a building is a capital cost).

Cut-off • Interest expenses and bank charges that are reconciling items on
the bank reconciliation statement must be included in accrued
expenses.
• An accurate cut-off of cash receipts and payments shortly before
and after the year-end must be established. The dates of recording
transactions in the cashbook will be compared with the dates
according to the bank statement through the bank reconciliation.
Accuracy • Interest received (and/or payable) should be agreed between the
cash book and bank statement.
• Interest rates (and related expenses such as bank charges) should
be specified in loan agreements.
Loans (received) procedures
The audit procedures for loans (received) are as follows.

• Obtain schedules of all loans, reconciling opening balances, movements in year

and closing balances (agreeing to the general ledger and financial statements).

• Examine loan agreements noting:

• term of the loan;
• rate of interest (fixed or variable);
• security given; and
• repayment terms.

• Confirm redemptions during the year by reference to:

• authority (e.g. board minutes);
• paid cheques and cash book entries;
• the calculation of any discount or premium;
• accrued interest paid; and
• deletions in the register of holders of loans.

• Verify new loans/debentures issued during the year by reference to:

• trust deed;
• authority;
• receipt of monies in cash book and general ledger; and
• entries in statutory records.

• Obtain direct confirmation from lenders.

• Scrutinise statutory books (if any) and confirm that they are correct regarding:
• charges over assets; and
• directors' interests in debentures.

• Re-compute interest charge and interest accrual calculations.

• Agree disclosure of long-term liabilities in accordance with financial reporting

framework. For example:
• secured loans excluding portion repayable within one year;
• unsecured loans excluding portion repayable within one year;
• summary of interest rates, repayment terms, covenants; and
• security given.
Bank reconciliation procedures

Exam advice
The concept and construction of a bank reconciliation is assumed
knowledge of Financial Accounting.

The audit procedures for bank reconciliation procedures are as follows.

• Review any interim audit work carried out on the cash system to identify
potential problems for the year-end work.

• Confirm the balance per the bank statement (e.g. to the bank report for audit
purposes) and agree the cash book balance to the general ledger.

• Verify that the reconciliation casts (i.e. adds up) by reperforming the additions.

• Audit the adjusting items (e.g. interest charges).

• Agree uncleared (‘outstanding’) deposits and unpresented cheques to entries

on the bank statement dated after the end of the reporting period.

• Reconcile the year-end closing balance from the prior year's audited
reconciliation via each bank reconciliation carried out.

• Review each reconciliation during the year, for unusual ‘balancing’ items.
Petty cash procedures
The audit procedures for petty cash are as follows.

• Understand the system of control over petty cash.

• Carry out a count/s of petty cash (in the presence of a client employee) and agree
to the balance in the petty cash book, general ledger and financial statements.

• If the imprest system is used, add up the petty cash vouchers and agree the total
amount of cash and vouchers as being equal to the imprest balance.

• At the end of the count, return cash to the cashier and obtain a signed certificate
of the monies returned.

• Agree the petty cash vouchers for appropriate authorisation and supporting
receipts/documentation.

• Review the petty cash book for unusual items (i.e. items that are clearly not petty
cash), for example ‘weekend’ loans to directors or items which should be paid
through the main cashbook system (e.g. repairs to office equipment).

• If cash is being counted in more than one location (e.g. tills in a department store)
ensure that the cash cannot be transferred between locations during the cash
count (e.g. by involving more than one auditor in the counts).
5. Tangible and intangible non-current assets

Procedures for tangible non-current assets

Asset
An asset is a present economic resource controlled by the entity as a result of past
events.

Non-current
Non-current means that the asset is not working capital and is not routinely traded; but
used to generate revenues and is expected to remain in the business for at least 12
months after the reporting period.

Assertions for property, plant and equipment

Audit considerations for the assertions that are specific to property, plant and equipment
include the following.

Completeness Assets may be understated if:

• Expenditure of a capital nature is mis-posted to an expense
account;
• Disposals are not recorded (i.e. the asset is not derecognised).

Accuracy, • The depreciable amount of all non-current assets must be

Valuation and depreciated each year and expensed to profit or loss.
Allocation
• If revalued, the revalued amount must be verifiable (e.g. a market
value or expert valuation). Any revaluation gain must be correctly
accounted for and the surplus recognised in the statement of
changes in equity (IAS 16).
• If there are indicators of impairment (e.g. damaged assets, assets
not in use, reduced capacity of production, negative change in
market conditions), impaired assets must be written down to
recoverable amount.
• The cost of self-constructed assets should include relevant
overheads as well as materials and labour costs.

Rights • Physical possession is evidence of control but is not conclusive

(Control) evidence of ownership.
• Control without ownership may signify a liability (e.g. a lease
liability for a leased asset).
• Assets may be owned but not possessed (e.g. if they are leased to
another party).
Existence • Overstatement will also arise if disposals of assets have not been
recorded.

Additions
• Obtain list of additions from client (or extract a list from the asset register).

• For appropriate sample (e.g. all material items):

• agree to delivery received confirmation and purchase invoice (completeness
and occurrence)
• agree value, treatment of sales tax, description and account allocation to
purchase invoice ensuring invoice is addressed to entity and that invoice
correctly casts (accuracy, classification);
• if self-constructed, obtain cost analysis for materials, labour and appropriate
overheads. Agree material to purchase invoices, agree labour to time
records (ensure labour is relevant and not capitalised production labour),
agree overheads as reasonable and to supporting documents
(completeness, occurrence, classification);
• agree correctly posted to asset register (completeness).

• Review expense accounts for possible mis-postings (e.g. repairs and

maintenance) to ensure no material items of a capital nature have been written
off through profit or loss (completeness, classification).

• Review non-current asset purchases from shortly before and after year-end for
recording in the proper period (cut-off).

Revaluations
• If the IAS 16 revaluation method is accounting policy, assess whether assets
should have been revalued during the year (e.g. high property inflation)
(valuation and allocation).
• Revaluation gains (and losses) should be recalculated (accuracy).
• Where an asset has been revalued, confirm that requirements of IAS 16 have
been applied (e.g. all assets in the same class also revalued). Apply audit
procedure relevant to reliance on management's expert (accuracy, valuation
and allocation).
Rights
• Inspect evidence of control or ownership for material assets, for example:
• property title deeds (may be held as security by bank);
• vehicle registration documents;
• ‘put into use’ certificates;
• lease agreements.

Existence
• For appropriate sample (e.g. material items), inspect each asset and note if
damaged or obsolete (existence, rights, valuation). The asset register is usually
used as the basis for selecting the sample, provided it is independently
maintained from the general ledger.

• If asset is not accessible (e.g. container on board boat, lorry travelling across
Europe) inspect other documentary evidence for proof of existence (e.g. GPS
location if used by company, licence, insurance, fuel costs, maintenance,
contracts of hire/ use by customers).

• Consider conducting asset inspection at year-end during inventory observation

to improve audit efficiency.
Disposals
• Obtain list of disposals or identify from general ledger and asset register.
Disposal testing relates to the existence of non-current assets and the
completeness of the recording of disposals.

• Incorporate testing of disposals into existence test:

• Select items for inspection from opening balances and additions in year.
• If asset cannot be found, check that it is on list of disposals or was disposed of
after the year-end (inspect evidence of such sales).
• If an asset is not on list of disposals, make enquiries of management.

• For material disposals, verify:

• Extraction from records;
• Authorisation to dispose;
• Proceeds received and banked;
• Write-off of accumulated depreciation;
• Recording of profit or loss on disposal.

• Profit or loss on disposal is tested through recalculation by comparing the

proceeds received (if any) to the carrying amount of the asset at the time of
disposal.
Depreciation
• Confirm that depreciation has been systematically applied to all depreciable
assets including additions to reflect consumption of economic benefits
(completeness).

• Confirm that no assets have a negative carrying amount (accuracy, valuation) as

depreciation of an asset ceases when it is ‘fully written down’.

• Confirm that assets disposed of have been depreciated, or not, in accordance

with the accounting policy (e.g. no depreciation in the year of disposal or on a
monthly basis until the date of disposal).

• For assets revalued, confirm correct treatment of accumulated depreciation and

that the charge for the year reflects the revalued amount (accuracy, valuation,
allocation).

• Recalculate depreciation on material assets and that entries have been made
appropriately in the records (accuracy, valuation).

• Review rates applied in relation to asset lives, replacement policy and past
experience of gains/losses on disposal (valuation).

Key point
Analytical procedures which could be used to test depreciation (accuracy,
valuation, allocation) include:
• Reasonable tests (e.g. reconciling current year's charge to prior year's as
adjusted for additions, disposals and revaluations in current year);
• Comparison of ratios of depreciation expense to the related depreciable
asset accounts with prior year ratios.

Impairment

• Obtain a schedule of impaired assets and confirm that potentially impaired assets
identified during physical inspection are included (valuation).

• Agree management's estimate of recoverable amount (e.g. net disposal proceeds if

replaced after the reporting date).
Disclosure Requirements (IAS 16)

• Accounting policy, measurement basis used, useful lives or depreciation rates (for
each asset category).

• Gross carrying amount and accumulated depreciation at beginning and end of year
and reconciliation showing additions, revaluations, disposals, depreciation for year
(see lead schedule above).

• The existence and amounts of restrictions of title to assets and assets pledged as
security for liabilities.

• The amounts for:

• expenditures recognised in assets in the course of construction;
• contractual commitments (to acquire assets);
• third-party compensation for assets impaired, lost or given up, which are included
in profit or loss.
Procedures for intangible non-current assets

Additions
• Obtain list of additions from client (or extract a list from the asset register).

• For appropriate sample (e.g. all material items):

• Agree value, treatment of sales tax, description and account allocation to
purchase invoice, ensuring invoice is addressed to entity and that invoice correctly
casts (accuracy, classification).
• Agree supporting documentation (e.g. certificate of registration of
patent/trademark) (occurrence).
• If self-developed, obtain cost analysis for materials, labour and appropriate
overheads. Agree material to purchase invoices, agree labour to time records
(ensure labour is relevant and not capitalised production labour), agree overheads
as reasonable and to supporting documents (completeness, occurrence,
classification).

• Agree correctly posted to asset register (completeness).

Revaluations
• For most intangible assets, it is unlikely that a fair value could be determined (e.g.
an appropriate market does not exist).

• Agree that carrying amount has not been impaired (valuation).

Rights
• Inspect evidence of control or ownership for material assets (e.g. registration
certificate).

• Income streams from the use of right provide corroborative evidence.

Existence
• For appropriate sample (e.g. material items), agree use of asset within the business
or appropriate income stream from use of asset by an external entity.
Disposals
• Disposal testing relates to the existence of intangible assets and the completeness
of the recording of disposals.
• Obtain list of disposals or identify from general ledger, asset register and
discussions with management.
• Agree proceeds to cash book and bank account.
• Confirm extraction from records of cost and accumulated amortisation and
recalculate profit or loss on disposal (existence, completeness, accuracy).

Amortisation
• Confirm that amortisation has been systematically applied to reflect the
consumption of economic benefits and that no assets have a negative carrying
amount (completeness, valuation). Amortisation should be on a straight-line basis if
the pattern of consumption cannot be determined reliably (IAS 38 Intangible
Assets).

• For assets revalued, confirm correct treatment of accumulated amortisation and that
the charge for the year reflects the revalued amount (accuracy, valuation, allocation).

• Test check calculations on material assets and that entries have been made
appropriately in the records (accuracy).

• Review rates applied in relation to asset lives, replacement policy (if any) and past
experience of gains/losses on disposal (valuation).
6. Provisions and contingencies

Procedures
• Discuss with management the systems for identifying provisions and contingent
liabilities.

• Review the prior year's financial statement provisions and contingent liabilities.
• Establish provision outcome, if estimation was reasonable or if continuous (e.g.
warranty provisions).
• Establish the outcome of contingent liabilities (e.g. Do they no longer exist? Are
they continuing or do they need to become provisions?).

• Review year-end and after-date correspondence and board minutes for evidence of
new litigation and claims against the entity.

• Review subsequent events to ensure that all relevant matters are considered.

• Examine legal expense accounts for indications of higher-than-normal costs. Discuss

with management the reasons for these.

• Reassess the need for continuing provisions (e.g. estimate warranty provision).

• Review supporting documentation to assess new provisions/contingent liabilities and

estimate potential outflows.

• Discuss with management its assessment of the outcome, its estimate of financial
implications and the costs involved. Remember that if the event gives rise to a
contingent liability such as a lawsuit, an accrual or provision should be made for
associated legal expenses.

• Seek confirmation from company lawyers (they may be an internal or an external

expert).

• Obtain written representations from management. If permission is not given to

communicate with lawyers, or the lawyers refuse to discuss matters with the auditor,
or management refuses to provide written representations on a particular matter, the
auditor must consider a scope limitation on the auditor's report.
7. Share capital, reserves, and directors’
remuneration
Audit considerations for the assertions that are specific to share capital, reserves and
directors' remuneration include the following:

Completeness • All equity transactions must be accounted for and disclosed.

• All directors' remuneration and other transactions with directors
should be recorded and disclosed.

Accuracy, • Equity transactions must be correctly recognised, movements

Allocation valued and allocated to the appropriate accounts.
and Valuation
• Directors' remuneration and other transactions must be
recognised/disclosed at correct amounts.
• The requirements of applicable IFRS Standards must be met (e.g.
share-based payments, share options, revaluations, foreign
currency translations, financial instruments).

Existence • Equity transactions, as recorded or disclosed, occurred and related

to the entity.
• All equity transactions have been recognised in the appropriate
period.
Procedures for share capital

Ordinary shares
Audit procedures for ordinary shares include the following.

• Review permanent file to understand the equity structure, memorandum and articles
of association, and the relevant laws and regulations. For example, whether the
company can purchase its own shares or reduce capital.

• Conduct company search and confirm current information held by authorities to the
company's books and records.

• Review minutes of all board and committee meetings and identify any matters
relating to share capital and reserves (e.g. making a rights issue).

• Discuss with management if any changes were made to the capital structure (e.g.
new share issues, share buy-back) during the period.

• Obtain a schedule of equity categories and movements from management.

• Agree opening balances to prior-year closing balances.
• Agree movements as detailed below.
• Agree closing balances to statutory records, accounting records, trial balance, and
financial statements including disclosures. Effectively, the schedule of movements
on equity will be included in the statement of changes in equity.

• Review statutory records to identify changes made and obtain confirmation from the
company secretary concerning changes made.

For changes in stator records, the auditor should agree that appropriate actions were
taken, for example:

• Authorised (e.g. by the board) and recorded (e.g. board minutes).

• Where required, approved by shareholders (e.g. share issues).

• Allowed by legislation, memorandum and articles of association.

• Recorded in statutory records (e.g. share register) and legally required returns made
to the appropriate authorities.

• Recalculate share capital where new issues (including rights issues) have been made
during the year. If issued at a premium agree that the excess over the nominal value
is credited to a share premium reserve.

• Agree proceeds of issues (other than bonus issues) to the cash book and bank
statement.
 Key point
A bonus issue is a capitalisation of reserves; it does not raise cash.

Preference shares
Preference shares may be redeemable or irredeemable:

• Redeemable shares may or may not have a specific redemption date;

• Irredeemable shares cannot be repurchased.

If new preference shares were issued during the year, the auditor should, as for ordinary
shares:
• Agree authorisation;
• Confirm proceeds received;
• Update the permanent audit file.

If any shares were redeemed during the year, confirm that the terms of redemption
have been complied with and any statutory requirements met. (Statutory requirements
tend to be very strict concerning any reduction in capital.) For example:
• Only fully paid-for shares can be redeemed;
• Any premium on redemption reduced the share premium account (if any) or is out of
retained earnings.

The auditor should also:

• Agree payments to redeem shares to the cash book and bank statement.
• Agree the calculation of dividends (usually a fixed percentage of the nominal value
of the shares in issue) and dividend payments to the cash book and bank statement.

If the company has insufficient profit and/or cash to pay preference dividends but the
shares are ‘cumulative’, unpaid dividends will accrue to the preference shareholders. A
liability will be recognised if the company has a legal obligation to pay them (e.g. if the
dividend was ‘declared’ in a general meeting) or otherwise disclosed in the notes.
Procedures for reserves
For each reserve the auditor should:

• Agree that it is allowed in accordance with the entity's constitution, legal or GAAP
requirements. (For example, reserves for ‘repairs and maintenance’ are not permitted
under IFRS.)

• Agree that it has been correctly used in accordance with the constitution, legal or
GAAP requirements. For example, a share premium account has limited uses such as
for the issue of bonus shares and cannot be distributed as dividends.

• Obtain, or prepare, a reconciliation of the movement agreeing:

• opening balances to the prior-year closing balance;
• closing balance to the accounting records and financial statements;
• movement suitably broken down into required components as required by GAAP;
• required components supported by audited evidence.

Procedures for dividends

• Agree that dividends have been made from profits available for distribution as defined
by relevant company legislation and the entity's articles of association.

• Confirm that only distributable reserves have been used for distributions.

• Confirm that dividends declared or paid have been correctly authorised, documented
and accounted for. A dividend declared after year-end is not a liability at the reporting
date under IFRS (IAS 10).

• Recalculate dividends in accordance with declared rate and participating shares.

• Agree a selection of dividends paid to the shareholders' register and the cash book.

• Recalculate the tax impact of distributions and that tax liabilities correctly accounted
for and subsequently paid (e.g. withholding taxation).

• Agree that the provisions of any double taxation treaties for relevant countries have
been met.

Key point
Dividends are not an expense but an appropriation of profit.
Procedures for directors’ remuneration

General
In public companies in particular, directors’ remuneration are likely to be a material
expense. Directors’ remuneration include:

• Fees paid for services rendered as directors;

• Basic salary;

• Bonuses and performance-related payments;

• Expense allowances;

• The estimated monetary value of material benefits received (e.g. company car);

• Pension contributions paid; and

• Gains made on the exercise of share options.

Regulation
The auditor must have a thorough understanding of the legal, regulatory and other
requirements concerning directors' remuneration, for example:

• Companies' legislation that may distinguish between disclosure requirements of large,

medium and small companies.

• Listing rules meaning a higher level of disclosure for listed companies.

• Corporate governance requirements (e.g. remuneration committee reports).

• Regulatory requirements (e.g. the UK's Directors' Remuneration Report Regulations)

that may only apply to specific entities (e.g. listed companies, banks).

Audit approach

• Understand the nature of the business and the potential for undisclosed directors'
transactions.

• Discuss with directors and TCWG (e.g. remuneration committee) the controls in place
to identify, value and record directors' remuneration and transactions.

• Review directors' contracts of employment and service contracts to establish

remuneration components and levels of compensation.

• Agree bonus schemes correctly approved and meet appropriate criteria (e.g. as laid
down by corporate governance codes, regulations or recommendations from
governance bodies).
• Agree compensation paid in kind to appropriate records (e.g. issue of shares, share
options) and repeat valuation calculations (e.g. fair-value estimations of share options).

• Agree all compensation transactions correctly recorded in the books and records.

Key point
For any company, directors' remuneration is material by nature where there is a
requirement to disclose this information in the notes to the financial statements.