Week 10

Question 1

Differences between auditing income statement and balance sheet accounts:

Answer 1

Balance sheet accounts typically represent only recent transactions, or one-off transactions.
Income statement accounts reflect sum of entire reporting period transactions.
Testing balance sheet accounts do not provide much assurance about income statement accounts

Question 2

Difference in nature of account is reflected in difference in testing.

Answer 2

Typically use analytical procedures for income statement accounts rather than confirmations etc.

Question 3

Extent of substantive procedures:

Answer 3

As discussed for balance sheet accounts, extent of testing determined by risk assessment for each significant account or disclosure.

High IR, CR:
Do not rely on and test controls, use significant amount of substantive testing to reduce DR.

Low IR, CR:
Testing controls shows them to be effective, limited substantive testing required.

Question 4

Timing of substantive procedures:

Answer 4

Dependent on risk assessment, can perform some types of work prior to year-end, leverage off internal audit etc.

Question 5

Sales is usually a very significant account:

Answer 5

Pressure to achieve sales targets creates risk of overstatement:
high overall inherent risk
e.g. manipulation and fraud.

Also significant because:
material size
high volume of transactions.

Auditors usually either use only substantive testing techniques, or use controls testing supplemented with high-level analytical procedures.

Question 6

Substantive testing of revenue

3

Answer 6

Occurrence:
Test recorded sales are bona fide and have occurred.

Accuracy:
Sales are recorded at correct amount, not overstated.

Cut-off:
Risk that sales occur after year-end are recorded early.

Question 7

Processes affecting sales revenue:

Answer 7

Sales and sales returns and allowances.
Consider evidence from interim testing and control testing phase.
If substantive testing required, use detailed testing such as vouching, tracing of documents, recalculating pricing and discounts and testing postings.

Question 8

Substantive testing of cost of sales and other significant expenses

Answer 8

Cost of sales and expenses are significant accounts in income statement.
Major risk relates to understatement.

Question 9

Substantive testing of cost of sales and other significant expenses

Key assertion 1

Answer 9

ACCURACY:
Verify by vouching recorded amounts to documents or underlying account.

For example:

Depreciation: tested as part of verifying PPE balance.

Bad debts: part of verifying receivables balance.

Cost of sales is verified to:
Opening stock balance (last year closing balance).
Purchases and payables.
Closing stock balance part of inventory valuation.

Purchases typically subjected to additional testing through controls testing, and if necessary, vouching to supplier documentation.

Payroll expense vouched to time cards, employee lists:
Consider employees who leave during period.

Question 10

Substantive testing of cost of sales and other significant expenses

Key assertion 2

Answer 10

Completeness and cut-off:
Assertions combined:
Auditor to verify that client has not understated expenses and cost of sales by deferring recording expenses to next period.
Examine invoices around year-end to verify dates.

Question 11

Assessing the results of substantive procedures

Answer 11

Nature of tests similar to purchases and payroll.
Use risk assessment based on knowledge of client and professional judgement to determine timing and extent of testing.
Auditor’s objective is to determine if there are misstatements within the account balance and to quantify the amount of any misstatement.

Question 12

If error identified:

Answer 12

Understand why it occurred.
Consider increase to sample size.
Consider additional testing.
Continue testing until error can be accurately quantified or balance fully tested to ensure no error remains.