Assertions and audit evidence

Welcome to Audit Evidence and Assertions!

Welcome! In this chapter, we are diving into the heart of auditing. Think of an auditor as a financial detective. When a company produces its financial statements, they aren't just giving us numbers; they are making a series of "claims" about those numbers. Our job is to find the evidence to prove whether those claims are true or false.

Don't worry if this seems a bit technical at first. We’ll break it down using everyday examples so you can master this core part of the ACCA syllabus.

1. What are Financial Statement Assertions?

When management prepares financial statements, they are "asserting" (claiming) that everything is correct. For example, if the accounts show $10,000 in "Cash at Bank," management is asserting that the money exists, that it belongs to the company, and that the amount is correct.

We divide these assertions into three categories to make them easier to test:

A. Assertions about Transactions (Income Statement)

These relate to events that happened during the year (Sales, Expenses, Dividends paid).

Mnemonic: ACCA CO

1. Occurrence: The transactions actually happened and relate to the entity. (Did that sale really take place?)
\n2. Completeness: Everything that should have been recorded has been recorded. (Did we miss any expenses?)
\n3. Accuracy: The amounts were recorded correctly. (No typos in the numbers!)
\n4. Cut-off: Transactions are recorded in the correct accounting period. (Is a January sale accidentally recorded in December?)
\n5. Classification: Transactions are in the right accounts. (Was a repair expense accidentally put into "Assets"?)

B. Assertions about Account Balances (Balance Sheet)

These relate to the "ending balances" at the year-end (Inventory, Buildings, Loans).

Mnemonic: CEREV

1. Completeness: All assets, liabilities, and equity that should be there are included.
\n2. Existence: The assets, liabilities, and equity actually exist. (Is that delivery truck actually in the parking lot?)
\n3. Rights and Obligations: The company actually owns the assets and owes the liabilities. (Is that truck leased or owned?)
\n4. Evaluation and Allocation (Valuation): Assets and liabilities are recorded at the right amounts (e.g., checking for depreciation or bad debts).
\n5. Classification: Items are in the right place (e.g., Current vs. Non-current).

C. Assertions about Presentation and Disclosure

This is about how the information is shown in the final reports. Is it clear? Are the notes in the back of the accounts accurate and easy to understand?

Quick Review: Assertions are the "claims" management makes. If management says they have $1 million in Inventory, they are claiming it exists (Existence), they own it (Rights), and it is valued correctly (Valuation).

Key Takeaway: Auditors don't just "check the numbers." They test specific assertions to ensure the financial statements are not misleading.

2. Audit Evidence: What counts as "Good" Proof?

To support our opinion, we need Audit Evidence. According to the rules, this evidence must be Sufficient and Appropriate.

Sufficient vs. Appropriate

1. Sufficient = Quantity. Do we have enough evidence? If the risk is high, we need more samples.
2. Appropriate = Quality. Is the evidence Relevant (does it test the right assertion?) and Reliable (can we trust it?).

Analogy: Imagine you are trying to prove your friend was at the cinema. One blurry photo (low quality) isn't great. Ten blurry photos (high quantity, low quality) still aren't great. One clear video with a timestamp (high quality) is much better!

The Reliability Hierarchy

Not all evidence is created equal. Here is the general rule of thumb for reliability:

1. External > Internal: Evidence from a bank (external) is more reliable than a spreadsheet made by the client (internal).
2. Direct > Indirect: Evidence the auditor finds themselves (like counting cash) is better than asking the client.
3. Written > Oral: A signed letter is better than a conversation.
4. Originals > Photocopies: Photocopies can be edited; originals are harder to fake.

Did you know? Even the best evidence has limitations. Auditors provide Reasonable Assurance, not a 100% guarantee, because we use sampling rather than checking every single transaction.

3. How to Get Evidence: Audit Procedures

How do we actually get the proof? We use the "AEIOU" mnemonic to remember the main types of audit procedures.

Mnemonic: AEIOU

1. Analytical Procedures: Looking at trends and ratios. Example: "Why are sales up 50% when the industry is failing?"
2. Enquiry: Asking management and staff questions. (Note: Enquiry alone is never enough!)
3. Inspection: Looking at physical assets (like a machine) or documents (like an invoice).
4. Observation: Watching a process happen. Example: Watching the client's staff count inventory at the warehouse.
5. re-calcUlation / re-performance:
- Recalculation: Checking the math (e.g., re-adding an invoice).
- Re-performance: Redoing a procedure the client did (e.g., re-doing a bank reconciliation) to see if you get the same result.

Common Mistake to Avoid: Many students confuse Observation with Inspection. If you look at a fixed asset (the machine), it is Inspection. If you watch a person doing their job, it is Observation.

Key Takeaway: Auditors use a mix of AEIOU procedures to gather Sufficient and Appropriate evidence to test management’s Assertions.

4. Matching Assertions to Procedures

To pass the AA exam, you must be able to link a procedure to an assertion. Don't worry, there is a logic to it!

Example 1: Testing Inventory

- Procedure: Select a sample of items from the warehouse floor and trace them back to the inventory records.
- Assertion: Completeness (We are checking if anything was left off the list).
- Procedure: Select a sample of items from the inventory records and find them on the warehouse floor.
- Assertion: Existence (We are checking if the items on the list actually exist).

Example 2: Testing Trade Receivables (Money owed by customers)

- Procedure: Send a confirmation letter to a customer to ask how much they owe.
- Assertion: Existence and Rights & Obligations.

Quick Tip: If a question asks about Valuation, look for procedures involving "money," "calculations," "aging," or "market value." If it asks about Completeness, look for procedures that start outside the accounting system (like physical items) and move into the system.

Summary Checklist

Before you move on, make sure you can answer these:

1. Can I list the ACCA CO assertions for transactions? (Yes/No)
2. Can I list the CEREV assertions for balances? (Yes/No)
3. Do I know why External evidence is better than Internal? (Yes/No)
4. Can I explain the AEIOU procedures? (Yes/No)

Great job! You've just covered one of the most important chapters in Audit and Assurance. Keep practicing matching the procedures to the assertions, and you'll be an expert in no time!