Welcome to the "Heart" of the Audit!
Hi there! If you’ve been following the Audit and Assurance (AA) syllabus, you’ve already learned about the "rules" of evidence. Now, we are getting into the exciting part: The Audit of Specific Items. This is where we stop talking about theory and start looking at how we actually check the numbers in the financial statements.
Think of an auditor like a detective. Management has given you a "story" (the financial statements), and your job is to find the proof (evidence) to see if that story is true. Don't worry if this seems like a lot of detail at first—we’re going to break it down item by item using simple logic!
Quick Reminder: In this chapter, we focus on Substantive Procedures. These are the actual tests we do to find "material misstatements" (big mistakes) in the numbers. We are checking Assertions like: Is it really there? (Existence), Do they own it? (Rights and Obligations), and Is the math right? (Accuracy/Valuation).
1. Auditing Inventory (The Warehouse Check)
Inventory is often the "riskiest" item because it involves counting thousands of items and deciding what they are worth.
The Inventory Count (The Big Event)
As an auditor, you don't usually count every single item yourself. Instead, you observe the client’s staff doing the count. This checks for Existence.
• Before the count: Review the client's instructions. Are they organized? Will they stop production so items aren't moving around?
• During the count: Perform "test counts."
- Floor to Records: Pick an item on the warehouse floor and see if it's on the sheet (Checks Completeness).
- Records to Floor: Pick an item on the sheet and go find it on the floor (Checks Existence).
Valuation: How much is it worth?
Inventory must be valued at the lower of Cost and Net Realisable Value (NRV).
Formula: \( \text{NRV} = \text{Estimated Selling Price} - \text{Costs to Complete} - \text{Selling Costs} \)
Auditor Trick: Look for dusty or damaged boxes during the count. If an item is damaged, its NRV might be lower than its cost, and the value needs to be written down!
Key Takeaway: For inventory, we care most about it actually being there (Existence) and being valued correctly (Valuation).
2. Auditing Receivables (Money Owed to Us)
When customers owe the company money, how do we know they will actually pay?
Direct Confirmation (The "Letter" Method)
The best way to check receivables is to ask the customer directly. This is called a Circularisation.
1. We (the auditors) pick a sample of customers.
2. We ask the client to write a letter, but we mail it ourselves.
3. The customer replies directly to us (the auditor), not the client. This prevents the client from hiding bad news!
What if the customer doesn't reply?
Don't panic! If they don't answer, we use Alternative Procedures:
• Check Subsequent Cash Receipts: Did the customer pay the bill after the year-end? If they paid it in January, it proves the debt was real in December!
• Inspect sales invoices and delivery notes to prove the sale actually happened.
Did you know? Checking if a customer paid *after* the year-end is the strongest evidence for the Valuation of a debt. If they paid it, it's clearly worth that much!
3. Auditing Bank and Cash
Cash is the easiest thing to steal, so auditors are very careful here.
The Bank Confirmation Letter
We send a standard request to the client’s bank. We aren't just checking the balance; we are checking for:
• All bank accounts (even ones the client might have "forgotten" to mention).
• Loans or overdrafts.
• Any assets the bank is holding as security (collateral).
The Bank Reconciliation
The company's books almost never match the bank statement exactly because of "timing differences" (like checks that haven't cleared yet).
Step-by-step:
1. Get the year-end bank reconciliation.
2. Check the balance per the bank against the Bank Confirmation Letter.
3. Check the balance per the books against the General Ledger.
4. Re-calculate the math to ensure it adds up!
Common Mistake: Students often think auditors just look at the bank statement. We don't! We look at the reconciliation because it explains the gap between the bank's records and the company's records.
4. Auditing Non-Current Assets (Buildings, Vans, Machines)
Non-current assets (NCA) are usually expensive and stay in the business for a long time. Our main focus is Existence and Valuation (Depreciation).
Procedures for NCA:
• Inspection: Go and physically look at the asset. Does that specialized "Pizza Oven" actually exist? Check the serial number!
• Title Deeds: For buildings, check the legal documents to ensure the Rights and Obligations (the company actually owns it).
• Depreciation: Re-calculate the depreciation expense. Does the useful life seem reasonable? (If a van is 10 years old and still on the books for full price, something is wrong!).
• Additions: If they bought a new machine this year, look at the purchase invoice to confirm the cost.
Analogy: Imagine buying a used car. You’d check the physical car (Existence), look at the logbook (Rights), and check if the price is fair (Valuation). That's exactly what an auditor does for a company's assets!
5. Auditing Payables and Accruals (Money We Owe)
Here, the risk is different. Management might want to "hide" debts to make the company look healthier. This means we focus on Completeness.
The Search for Unrecorded Liabilities
This is a classic audit test! We look at payments made after the year-end.
Example: If the year-end is December 31, and we see a huge payment to a supplier in January for "Goods received in December," we check if that debt was recorded in the December books. If not, it's incomplete!
Supplier Statement Reconciliations
Suppliers send monthly statements saying "You owe us $X." We compare these statements to the company's "Purchase Ledger." If the supplier says we owe them more than we recorded, we need to find out why.
Memory Aid: For Assets, we worry about Overstatement (Existence). For Liabilities, we worry about Understatement (Completeness). Just remember: "Assets = Are they there? Liabilities = Are they ALL there?"
Summary Checklist for Students
When you are asked to write audit procedures in the exam, try to use the AEIOU mnemonic to help you think of actions:
• Analytical Procedures (Comparing this year to last year).
• Enquiry (Asking management questions).
• Inspection (Looking at documents or physical assets).
• Observation (Watching a process, like the inventory count).
• recalcUlation (Checking the math).
Final Tip: Always be specific. Don't just say "check the invoice." Say "vouch the purchase price of the asset to the supplier invoice to confirm the cost recorded." Specificity earns the marks!