OVERVIEW
Objective
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To describe practical methods used to collect audit evidence.RISKS SOURCES OF
EVIDENCE
C A P E R
¾ Trade payable & accrued expense
¾ Provisions
RECONCILIATIONS
¾ Provisions
¾ Contingencies
¾ Litigation
¾ Control a/c
¾ Individual supplier’s a/c
¾ “Cutoff”
¾ Trade payable & accrued expense
¾ Provisions
IAS 37
1
SOURCES OF EVIDENCE
1.1
Trade payables and accrued expenses
1.1.1
Distinction
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Both are liabilities to pay for goods/services received, however: trade payables have been invoiced or formally agreed with suppliers accrued expenses have not.
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Accruals are often reported as part of trade and other payables.Example 1
Complete the following ideas list for trade accounts payable and accrued expenses.
Solution
1.1.2
“Ideas list”
1.1.3
Examples
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Accounting systems ⇒¾
Documentation ⇒¾
Tangible assets ⇒¾
Management and employees ⇒¾
Customers and suppliers ⇒¾
Other third parties ⇒¾
Analytical procedures ⇒1.2
Provisions
1.2.1
Definition
Liabilities of uncertain timing or amount.
1.2.2
Recognition criteria [IAS 37]
(a) A present obligation (legal or constructive) as a result of a past event (b) An outflow of resources to settle the obligation is probable
2
RISKS
2.1
Trade payables and accrued expenses
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Liabilities incurred may be unrecorded (e.g. purchase invoices not processed). Financial statements do not reflect extent of liability and expenditure is understated.¾
Secured liabilities may not be identified and security may not be disclosed.¾
Accrued expenses (e.g. for goods/services received but not invoiced) relating to current year expenditure may be omitted.¾
Liabilities may be recorded/payments to suppliers made for goods not received (due to error or fraud).2.2
Provisions
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Liability may be excessive (i.e. overstated) – due to uncertainty in estimating amount.¾
Classification as current or non-current may be inappropriate – due to uncertainty oftiming.
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Liability may be overstated if a provision is not reversed when its settlement is no longer probable.3
RECONCILIATIONS
A comprehensive audit program for trade payables and accrued expenses is set out in Appendix 3.
3.1
Control account reconciliation
3.1.1
Proforma control a/c
Trade payables ledger control a/c $
Cash a/c (cash book) x Discounts received a/c (CB) x Purchase returns a/c
(purchase returns day book) x Trade receivables ledger contra
(journal) x
Balance c/f
(closing trade payables) __ x
$ Balance b/f
(opening trade payables) x
Purchases (credit) a/c
(PDB) x
3.1.2
Reconciliation
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To check the accuracy of client’s postings of individual transactions to individual suppliers’ a/cs and totals to the payables (ledger) control a/c.¾
Procedure as for trade accounts receivable.3.2
Suppliers’ statement reconciliations
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Unlike accounts receivable, good quality third party evidence in the form of suppliers’ statements may exist. These are the suppliers’ trade account receivable, sent to their customers to prompt payment.¾
The main audit procedure for the verification of trade payables and accrued expenses is the examination of suppliers’ statement reconciliations. It is essential that reconciling items are properly accounted for.¾
A limitation of this procedure is that the customer may not receive or keep statements from all suppliers. Additional steps will then be necessary to confirm existence and completeness of amounts payable, including: direct confirmation (i.e. requesting that the supplier provide a statement); cutoff tests on goods received; and
examination of post year-end payments and invoices.
Example 2
Describe how would you confirm the following items on a reconciliation of a balance per a supplier’s statement to the balance per the payables ledger a/c. (Assume suppliers’ statement and ledger a/c balances both as at the end of the reporting period.)
Solution
3.2.1
Reconciling item
3.2.2
How verified
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Purchase invoices on supplier’s statement not included in ledger a/c balance−
−
−
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Cash payments in payables’ ledger a/c not on supplier’s statement3.3
Cut-off
3.3.1
Purchases and payments
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Individual suppliers statement reconciliations identify items (see above) which are checked to ensure that cutoff between purchases/payables and cash is correct.3.3.2
Purchases and inventory
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The source document for checking the accuracy of cutoff it the goods received note (GRN).¾
Goods received before the end of the reporting period (i.e. included in inventory as at the end of the reporting period) must be included in purchases for the year and trade payables (or goods received not invoiced accrual)¾
Goods received after the end of the reporting period (i.e. excluded from end of the reporting period inventory) must be included in purchases for the next year and not included in trade payables at the end of the reporting period.4
IAS 37 PROVISIONS
4.1
Provisions
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See section 1.2 above for definitions and recognition criteria.4.1.1
Disclosure
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Amounts carrying amount at beginning and end of period additions and increases
amounts used (i.e. incurred and charged) unused amounts reversed
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Narrative nature of obligation and expected timing of outflows
uncertainties about amount or timing (and major assumptions made).
4.2
Contingent liabilities and contingent assets
4.2.1
Definitions
[IAS 37]
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Contingent liability(a) A possible obligation arising from past events whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
(b) A present obligation arising from past events (an “obligating event”) which is not recognised because:
(i) an outflow of resources is not probable; or (ii) it cannot be measured with sufficient reliability.
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Contingent asset – A possible asset arising from past events whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events¾
Uncertainty – Can be expressed by a range of outcomes.Quantified probabilities General description
Suggest a level of precision that is unlikely to be supported by available info
Using terms ranging from “probable” to “remote”
4.2.2
Accounting treatment [IAS 37] — Summary
Flow of resources
Obligation
Asset
Remote No disclosure No disclosure
Probably not/ Possible Contingent liability disclosure No disclosure Probable Provision (if reliable estimate) –
otherwise a contingent liability Disclosure required Expected/ virtually certain Provision Asset (not contingent)
4.2.3
Disclosure
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Nature of the contingent liability/asset4.3
Litigation and claims
4.3.1
Procedures [ISA 501]
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Make inquiries of management and obtain representations.¾
Review board minutes and correspondence with entity’s lawyers.¾
Examine legal expense accounts.¾
Use information obtained from discussions with any in-house legal department.¾
Seek direct communication with the entity’s lawyers. Letter prepared by management and sent by auditor, requests the lawyer to communicate directly with the auditor.
Ordinarily specifies
−
a list of litigation and claims−
management’s assessment of the outcome and estimate of financial implications, including costs involved. Requests lawyer to
−
confirm reasonableness of management’s assessments−
provide further information if the list is incomplete/incorrect.¾
In certain circumstances meet lawyer to discuss the likely outcome of litigation and claims.4.3.2
Permission to communicate refused
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Scope limitation ⇒ a qualified opinion or a disclaimer of opinion (see later session).FOCUS
You should now be able to:
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distinguish between: trade payables and accrued expenses;
provisions per IAS 37 and allowances against asset values;
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identify risks of misstatements and sources of evidence;¾
select appropriate audit procedures (including verification of suppliers’ statementEXAMPLE SOLUTION
Solution 1 — Sources of evidence
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Accounting systems ⇒ e.g. PDB = book of prime entry¾
Documentation ⇒ Purchaserequisitions/orders/invoices/GRNs, cheque payments
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Tangible assets ⇒ Inventories (raw materials, goods for resale)¾
Management and employees ⇒ Buyer, purchase ledger supervisor/clerks, chief cashier¾
Customers and suppliers ⇒ Suppliers (provide monthly statements?)¾
Other third parties ⇒ Intermediaries (e.g. warehousing agents)¾
Analytical procedures ⇒ Payable days outstanding, current ratio, accrued expenses to trade payables % or ratioSolution 2 — Supplier’s statement reconciliation
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Purchase invoices on supplier’s statement not included in ledger a/c balance¾
If accrued by client, inspect GRN (should be cross-referenced) and confirm dated before the end of the reporting period¾
If not accrued by client, confirm GRN dated after the end of the reporting period¾
Confirm any other reason for non-inclusion (e.g. if client wrongly invoiced should be supplier’s credit note on a statement after the end of the reporting period)¾
Cash payments in payables’ ledger a/c not on supplier’s statement¾
I.e. “cash-in-transit” – cheque should be raised in the cash book shortly before the end of the reporting period and clear bank shortly afterwards