FIXED ASSETS
You have found that land and buildings have been
revalued during the year. What work will you
perform to verify the revaluation?
The specific work involve will include:
Assess professional competence of the valuers. This
will involve (a)considering the professional
certification or licensing by, or membership in, an
approved professional body and (b) experience and
reputation in the field of valuers
Assess objectivity and independence of the valuers.
Assess appropriateness of the valuer’s work as audit
evidence for revaluation of the land building. This
will involve consideration of:
a) source data used
b) assumptions used
c) testing data used by the values
Consider that valuer is experienced in valuing
properties like those which have been restated at
revaluation by the client and the same geographical
area.
Discuss with the valuer the basis used to value the
property. Review documents in possession of the
valuers for source and reliability. Inquire the values
of current market pnces for similar and other
property.
Ascertain rental value of similar property to estimate
current value of
client’s property. Check local or national statistics
available for indices of properties.
How would you verify adequacy of accumulated
depreciation?
1. Assess reasonableness oflives of high value assets
2. Assess reasonableness of depreciation method used
in relation to pattern in which the asset’s future
economic benefits are expected to be consumed by
the client
3. Review estimate of residual value
4. Ensure that depreciation is recognized even if the
fair value of asset exceeds its carrying amount
5. In case of revaluation, depreciation should be
charged on revalued amount
6. Leased assets should be depreciated over lease
term, unless there is a reasonable expectation that the
assets will be transferred to lessee, in which case, the
leased assets may be depreciated over their useful
lives.
7. Excessive losses on disposal may indicate that
depreciation was inadequate.
8. Fixed assets register
9. Re computation
When the auditor verifies fixed assets, he should
perform two way test i.e., test some items from
accounting records to physical and some items form
physical to accounting records.
Explain the assertions to be verified and possible
audit adjustment case of discrepancies
The objective of checking accounting records to
physical is to ven; existence assertion. If there are
differences the matter should investigated. The write
off should be authorized. The objective of checking
physical to account records is to verify that assets
acquired are recorded.
How would you verify existence assertion of
investments?
Evidence that may be inspected for existence
assertion of investments include:
1. Physical inspection
2. Bank confirmation for investments held as
mortgage or safe custody
3. Receipt of dividend
List some control fixed relating to fixed assets
1. Non existent fixed assets included in balance sheet
2. Fixed assets may exist but not included in balance
sheet
3. Unauthorized purchased and disposals
4. Proceeds form disposals misappropriated
5. Fixed assets may not be owned by the entity.
6. Fixed assets mortgaged against loans not
disallowed
7 Capital and revenue expenditure incorrectly
classified
8 Inconsistent depreciation policy
9 Inadequate depreciation
How would you verify adequacy’ of depreciation
charge for fixed assets?
1 Inspect the property to ascertain reasonableness of
the remaining useful life
2. Compare depreciation charged witr the budget.
3. Consider assumptions on which management has
established
depreciation rates
4. Verify that the rates have been “)p~opnately
approved.
5. Depreciation rates used by otl e companies in the
same industry.
What procedures will you apply to verify possible
understatement of fixed assets?
Significant procedures to detect understatement of
non-current assets will include:
1. On a test basis select some equipment items and
trace to fixed assets register. Investigate items
pbysically found but not entered in fixed assets
register.
2. Review records of income yielding assets.
Ascertain relationship of income with value of assets.
3. Compare fixed assets register with general ledger.
Inquire reasons for not including in general ledger
cost of certain assets, if any, appearing in fixed assets
register.
4. Check whether any capital expenditure has been
charged to revenue.
5. Verify that finance leases have not been treated as
operating leases.
What matters would you consider in verifying
intangible assets?
(i) An intangible asset should be recognized if, and
only if:
(ii) An enterprises should assess the probability of
future econom, benefits using reasonable and
supportable assumptions represent management’s
best estimate of the set of economic conditions that
will exist over the useful life of the asset.
(iii) If an intangible asset is acquired separately , the
cost of the intangible asset can usually be measured
reliably. This is particularly so when the purchase
consideration is in the form of cash or other monetary
assets.
(iv) The cost of an intangible asset comprises its
purchase price, including any import duties and non-
refundable purchase taxes, and any directly
attributable expenditure on preparing the asset of its
intended use. Directly attributable expenditure
includes, for example, professional fees for legal
services. Any trade discounts and rebates are
deducted in arriving at the cost.
(v) If payment for an intangible asset is deferred
beyond normal credit terms, its cost is the cash price
equivalent; the differences between this amount and
the total payments is recognised as interest expense
over the period of credit unless it is capitalized under
the allowed alternative treatment in IAS 23,
Borrowing Costs.
(vi) If an intangible asset is acquired in exchange for
equity instruments of the reporting enterprise, the
cost of the asset is the fair value of the equity
instruments issued, which is equal to the fair value of
the asset.
(vii) Under IAS 22 (revised 1998 ) , Business
Combinations, if an intangible asset is acquired in a
business combination that is an acquisition, the cost
of that intangible asset is based on its fair value at the
date of acquisition.
How would you verify development expenditure?
1. Obtain or prepare a lead schedule of development
expenditure, check opening balances and verify the
total per lead schedule with the general ledger and
balance sheet.
2. Verify the costs incurred with supporting
documents
3. Review expected further costs of the project
4. Review estimates of the revenues to be generated
from use of the asset
5. Review estimated useful life
6. Review capitalization criteria as set out in IAS 38,
Intangible assets
• Technical feasibility of completing intangible asset
• Entity’s intention to complete the intangible asset
• Entity’s ability to sell or use the intangible asset
• Whether: intangible asset is likely to generate future
economic benefits
• Availability of technical and financial resources
• Ability to measure the expenditure attributable to
the intangible asset during development.
7. Verify that development costs are de recognized
when no future economic benefits are expected from
its use or disposal.
8. Review entity’s projected financial statements to
assess that amount deferred along with estimated
further costs do not exceed projected revenues
9. Assess reliability of projections
10. The gain or loss arising from de recognition of
deferred costs is the difference between the net sale
proceeds, if any, and the carrying value. The gain or
loss should be transferred to income statement
11. Following disclosure should be made
• Amortization method used
• Gross carrying amount and accumulated
amortization
• A reconciliation of carrying amount at the
beginning and end of the
accounting period, showing:
(i) Additions
(ii) Impairment
(iii) Amortization during period
• Development expenditure recognized as expense
during the period
List three risks and three evidential matters in
verifying development cost
Risks:
1. Development cost has significant inherent risk due
to nature of account and judgments involved.
2. Consider commercial viability. Be alert that the
product may not generate future economic benefit if
future revenues will not cover costs.
3. Bank may withdraw funding if certain
Evidential matter:
1. Verify that the licence to develop the product is
granted by appropriate authorities.
2. Compare actual cost to date with budgeted cost..
3. Review adequacy of amortization by comparing
actual sales after commercial production with
budgeted sales.
3. INVENTORIES
While verifying valuation assertion of inventories in
Sameer Manufacturing company, you have noted that
following costs have been fully charged to
inventories.
(a) Selling expenses
(b) General and administration expenses
(c) Interest paid
(d) Under recovery of overheads
Set out your comments on above
Selling expenses
Selling expenses are not considered to be directly
related to acquisition or production of goods. These
are more directly related cost of goods sold rather
than unsold goods. Selling expen es are, therefore.
not considered as part of inventory costs.
General and administrative expenses
General and administrative expenses are usually
excluded from cost of inventories because such
expenses are so unrelated or indirectly related to the
immediate production process that any allocation is
purely arbitrary. However, where some
administrative costs can be allocated as production
overheads on a systematic basis, for example, rent of
building or wages of the accounting staff dealing with
affairs of production may be included in cost of
inventories.
Interest costs
Interest costs associated with getting inventories
ready for sale are
charged to expenses as incurred. IAS 23, Borrowing
Costs, only allows capitalization of those borrowing
costs which are directly attributable to the
acquisition, construction or production of a qualifying
asset. Inventories that are routinely manufactured or
otherwise produced in large quantities on a repetitive
basis over a short period of time are not considered as
qualifying assets
Under recovery of overheads
Under recovery of overheads is not allocated to
products. This is recorded as expense of the current
accounting period.
IAS 2 states that allocation of fixed production
overheads to the cost of conversion is based on the
normal capacity of production.
Explain what you understand by normal capacity
Normal capacity is the production expected to be
achieved on an average over a number of periods
(often five years) under normal circumstances, taking
into account the loss of capacity resulting from
planned maintenance, seasonal, cyclical and trend
factors. The amount of fixed overheads allocated to
each unit of production is not increased as a
consequence of low production or idle plant.
Unallocated overheads are treated as period costs. In
period of abnormally bigh production, the amount of
fixed overheads allocated to each unit of production
is decreased so that inventories are not measured
above cost
Capture
Inventory counted on December 31 20x? was 25 units
Selling expenses are estimated to be 10% of sales.
Required
Compute the value of inventory to be reported in
financial statements for 20x?
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G Mart Super Stores has adopted following procedure
for valuation of year-end inventory. Records of cost
retail value of the goods available for sale are
maintained. The cost to retail percentage is applied to
closing inventory at retail price to determine
inventory at cost.
The accounting records reflect:
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Required
Your comments on the acceptability of the inventory
valuation method of G Mart
Generally the super market inventory consists of
thousands of different type of merchandise at low
unit costs. The application of unit cost to inventory
quantities is too cumbersome and time consuming. In
most super markets, a relationship between cost and
sale price may be determined. Use of such
relationship to estimate inventory cost is quite
legitimate. Inventory on hand can be valued at the
selling prices marked on merchandise. The cost to
retail ratio is applied to the goods on hand at selling
price to determine cost of closing inventory. The
percentage used takes into consideration inventory,
which has been marked down to below its original
price. .
This method, commonly known as retail method is
allowed by IAS-2 in retail industry for measuring of
large number of rapidly changing items that have
similar margins and for which it is impracticable to
use other costing methods.
A serious limitation of this method is that it is based
on average mix. It may result in incorrect inventory
valuation if mix of the closing inventory is not the
same as the mix of goods available for sale, assume
that the cost to retail ratio of 80% consists of equal
proportion of inventory items that have cost to retail
ratio of 75%, 80%, and 85%, respectively. If the
closing inventory contains. only items with 75%
ratio, the value of closing inventory will be incorrect.
This problem can be minimized by applying the retail
method on product – line or departmental basis.
Discuss auditor’s duties as regards observation of
physical inventory, before, during, and after the count
Before physical Inventory
1. Evaluate client’s planning of physical inventory.
The evaluation of client’s planning will require
consideration of following matters.
a) Designating by client’s management of an
individual employee, preferably a representative of
finance department, to assume responsibility for the
physical inventory
During physical Inventory
It is not auditor’s function to take inventory or to
control or supervise the stock taking; this is the
responsibility of management. The auditor’s
responsibility is to observe the inventory taking,
However, to observe the inventory taking implies a
much more active role, than that of a mere spectator.
In this regard auditor’s duties are:
1. Determining that all usable inventory owned by the
client is included in the count.
2. Inventory taking instructions are complied.
3. Be alert of inclusion of any obsolete or damaged
inventory.
4. Record serial number of the final receiving and
delivery documents issued before taking of inventory
so that accuracy of the count cut off can be
determined at a later date.
5. Closely observe delivery and or receipt of goods
taking place during the counting process and any
reconciliation made.
6. Observe that the client is controlling the inventory
sheets or tags properly.
7. Test count selected inventory items, both from
physical to coun: sheets and from count sheets to
physical
8. For test count of work in process, the auditor must
ascertain percentage or stage of completion indicated
on inventory tag if appropriate.
9. Ascertain that numerical control is maintained over
both inventory
tage and inventory sheets.
10. Make inquires to ascertain whether any of the
materials or goods on hand are the property of others,
such as goods held on consignment or customer –
owned materials sent in for machine work or other
processing.
11. Prepare working papers indicating:
i) Extent of test counts
ii) Deficiencies noted
iii) Conclusion as to whether the physical inventory
appeared to have been properly taken in accordance
with client’s instructions.
After physical inventory
1. Obtain a copy of completed physical inventory.
2. Test extensions and footing of the final inventory
listing
Here the auditor should be alert of:
i) Misplaced decimal points, for example an
inventory listing that extends 1,000 units times per
Re. 1 per hundred as Rs. 1,000, will be overstated by
Rs. 990
ii) Incorrect extension of count units with price per
unit.
3. Trace to the completed physical inventory, the test
counts performed earlier.
4. Determine that all inventory items are included in
the final stock
sheets
5. Check cut off with reference to last document
number noted at
physical count
Enumerate any 4 cut off procedures that you would
apply relating to inventories of December 31, 20×3
The relevant data is:
Untitled
1. Select GRN# 100 to 117 and check that all related
invoices have
been entered in the purchase day book in the year
ended December 31, 2003. If invoices have not been
received ensure that an accrual has been made. The
objective is to ensure that invoices relating to goods
received prior to year end have also been entered in
purchases.
2. Select suppliers invoice # 646 to 656 and match
with GRN. If any
Invoice bears GRN # prior to GRN 117 ensure that
related goods have been entered in purchases book of
year end ended December 31, 20×3 (provided risks
and rewards have been transferred)
3. Select Delivery notes numbers 930 to 945 and
ensure that related goods have been entered in sales
day book. Otherwise sales and debtors will be
understated.
4. Select delivery note numbers 946 to 956 issued in
the first week o: 20×4 to ensure that none of these
bears sales invoice prior to # 345 to avoid double
counting in both inventories and Receivables.
List down some audit procedures for verification of
stock held
controlled by a third party.
The auditor would obtain direct confirmation from
third party as to the quantities and condition of
inventory held on behalf of the entity.
Depending on the materiality of this inventory the
audit will also consider:
(a) integrity and independence of third party
(b) observing or arranging to observe physical
inventory count
(c) obtaining another auditor’s report on the adequacy
of third party’s internal control for ensuring that
inventory is correctly counted and adequately
safeguarded
(d) inspecting documentation regarding inventory
held by third parties
How would you verify allowance for slow moving
and obsolete
inventories?
1. Inquire of management procedures for identifying
slow moving and obsolete inventories
2. Carry out analytical procedures. An unusual
increase in number of days inventories may indicate
inadequate allowance for slow moving and obsolete
inventories. Consider following example. You are the
auditor for year ended December 31, 20×9. You have
carried out inventory turnover analysis from the
following data. (Rs. in millions) Year 20×9 reflects
significant increase in number of days. If the
company policy is still to maintain inventories for
two months, the allowance may be understated.
3. Obtain or prepare an age analysis of inventories
4. At the time of observation of physical count, note
rusty, dusty, damaged, spoiled and broken
inventories.
Untitled
You are the auditor of an entity engaged in the
trading of furniture. The entity has two warehouses
and employs about 200 employees. The management
has requested you to assist in preparing year-end
inventory count instructions. Develop inventory
count instructions which would require directors’
approval before these are issued by management to
count teams
Inventory count instructions
1. The inventory count will start at 9 AM sharp on
Jan 1, 2009.
2. We have two warehouses. Warehouse A and B.
3. There will be a pair of two count teams.
4. Mr. Pixie (from stores who is familiar with items)
and Mr. DiXIe from accounts will count inventories
in warehouse A.
5. Mr. Rick (from stores who is familiar with items)
and Mr. Shaw from accounts will count inventories in
warehouse B.
6. The count will be supervised by Mr. Wood.
7. Before inventory count:
(a) Last GR number, last supplier’s invoice number,
last ere note number, last sales invoice number and
last dispatch note number will be noted.
(b) Like items will be placed at one place
(c) Pre numbered count sheets will be given to the
count team
(d) Defective, spoiled and slow moving items will be
physical segregated
(e) Goods sold but not delivered will be identified
(t) Goods held for others will be separated
8. During the count no transfers will be made
between the two warehouses.
9. During the count no goods will be dispatched
except for emergency purposes details of which will
be recorded.
10. Goods received during count will be physically
separated.
11. In warehouse A, Mr. Pixie will count the items
and Mr. Dixie will enter the quantity on stock sheets.
He will then place a red sticker on the bin or shelves,
indicating that the item has been counted.
12. In warehouse B, Mr. -Rick will count the items
and Mr. Shaw will
enter the quantity on stock sheets. He will then place
a red sticker on the bin or shelves, indicating that the
item has been counted.
13. Once the count is complete, Mr. Pixie and Dixie
will visitwarehouse B and Mr. Rick and Shaw will
visit warehouse A and
start recounting.
14. The count teams will take out red sticker and
place blue stickers indicating that the item has been
double counted.
Why should an entity count inventories at year-end
when perpetual inventory records are available?
Even if perpetual inventory records are available,
inventory count is
required in order to:
• Confirm accuracy of perpetual records
• Identification of damaged, defective and spoiled
goods
When the auditor attends year end inventory count,
he should perform two way test, i.e., test some items
from count sheets to physical and courte items form
physical to count sheets.
Explain the assertions to be verified and possible
audit adjustments in case of discrepancies
The objective of checking count sheets to physical is
to verify existence assertions. If there are differences
the matter should be investigated and in case of
shortage, inventories should be taken on the basis of
physical count.
The objective of checking physical to count sheet is
to verify completeness assertion. On possibility could
be that related goods have been included in sales of
current period in order to inflate the revenue. Such
goods should have been included in inventories and
excluded form sales and receivables at year end
Your client carries out inventory count on a
continuous basis. What: matters would you consider
to verify the reliability of such count.
Following matters need be considered:
review the client’s records of inventory count
including basis selection ascertain action taken on
differences between book inventory physical
inventory ensure that all significant inventory items
are counted at least once a year
examine count sheet to ensure that slow moving an
ob 0 inventories are identified at the time of inventory
count.
List down steps to verify Net realizable value
1. Obtain age analysis of inventories and identify
slow items.
2. Obtain selling prices to verify unit selling price
3. Review reasonableness of further cost to incur and
direct selling expenses.
4. Verify subsequent selling prices
5. Review reports of stock takers for damaged and
defective items
6. Review quantities moved in subsequent period.
Some of the auditor procedures to be performed ill
the context of physical inventory court are:
1. Review prior year working papers
2. Review internal control weaknesses
3. Consider reliance on the work of internal auditor
4. Review client’s count instruction
5. Verify that count sheets are pre numbered
6. Obtain third party confirmation
7. Consider specialized nature of inventories
8. On a test basis compare quantities per count sheet
with physical
9. On a test basis compare physical with count sheets
10. Make notes of damaged, rusty dusty, defective
items
11. Note goods held for third parties
State briefly the objectives of each of the above audit
procedures.
1. A review of prior year working papers will help the
auditor to familiarize with the nature, approximate
volume, location, countprocedures, and problems
experienced. If the controls are weak, (for example”
inadequate security and access to inventory,
inadequate inventory records) a larger sample size
will have to be selected for physical count. Similarly,
it will be preferable to count inventory at year end
rather than before or after year end.
3. If reliance can be placed on the work of internal
auditor, the external auditor may request internal
auditor to attend physical count on some of the
locations.
4. Improvement may be suggested in count
instruction and as a result the year end inventory will
be more accurate
5. Pre numbering would be useful to verify
completeness assertion
6. To obtain evidence as regards existence of
inventories with third parties
7. Assistance of expert may be considered
8. Verification of counts sheets to physical will
provided evidence of existence
9. Verification of physical to count sheets will
provide evidence for completeness
10. Notes on rusty, dusty and damaged inventory will
be useful to ascertain NRV
Goods held for third parties, for example, on
consignment, should be excluded form inventories.
Discuss key issues in the verification of year end
inventories.
Key issues in verification of inventories are:
1. Existence
Inventories are susceptible to theft and pilferage. The
audi should review inventory count instructions,
observe inven – count, perform test counts and note
down condition of inventor,
2. Valuation
Particular attention is required in evaluating adequacy
provision for slow moving and obsolete inventories
3. Cutoff
Goods received notes and dispatch notes issued a few
before and after year end should be matched with
purchas
sales invoices to verify that transactions have been
recorded in the correct accounting period
How would you verify net realizable value of
inventory in a
manufacturing company.
1. Verify subsequent sales, in order to ascertain actual
selling price.
2. Verify subsequent payments for further costs
incurred, in orderto verify that estimated costs agree
with subsequent costs.
3. Consider whether any direct selling expenses are
necessary to sell the product. The purpose is to check
that direct selling costs, for example commission to
salesmen have been considered in ascertaining NRV
Your firm is the auditor of Shahzad Limited (SL), a
listed company, which is a wholesaler of consumable
products. SL records its sale on delivery of goods and
maintains up to date computerized inventory records.
A full inventory count was conducted at the year end.
The senior who attended the physical stocktaking at
the central warehouse has observed the following
matters:
(i) The inventory count took place on January 1, 2010
under the
supervision of the Inventory Controller. No
movement of inventory took place on that day.
(ii) Four counting teams were formed. Each team
comprised of two persons. The floor area was
allocated by the teams among themselves.
(iii) Each team was instructed by the Inventory
Controller to remember which inventory had been
counted.
(iv) Pre-numbered count sheets were provided to the
staff involved in the inventory count. The count
sheets showed the inventory ledger balances, to
facilitate reconciliation.
(v) Old, Slow-moving or already sold inventories
were highlighted on the count sheets at the time of
counting.
(vi) . Items not located on the pre-numbered
inventory sheets were recorded on separate sheets
which were numbered by the staff.
(vii) At the end of the count, all inventories against
which advances from customers had been received
were removed from the physical inventory on the
instruction of the Inventory Controller.
Required
Identify the weaknesses. in the system of inventory
count. Give
appropriate explanations to support your point of
view.
Following weaknesses In inventory count are
identified from audit senior’s observations:
(i) Lack of segregation of duties
The Inventory Controller is responsible for the
physical control of the inventory and is also
supervising the stock count.
(ii) Non availability of detailed plan
Allocation of counting area by the teams themselves
indicate non availability of detailed plan which may
lead to certain inventory items being counted more
than once while some items may not be counted at
all.
(iii) No system of marking on counted items
This again may lead to double counting or omission
completely.
(iv) Perpetual inventory records available on count
sheets
The person responsible for counting may try to match
the numbers provided instead of carrying out an
independent count.
(v) Additional count sheets are not pre-numbered
If the separate sheets are numbered as they are used,
there is no means of identifying that all sheets issued
have been returned and the last count sheet(s) may go
unnoticed
Set out five possible weaknesses in the system of
inventory count.
1. Inventory count instructions are not in writing
2. Count sheets issued to stock takers include
quantity per records
3. Count team members are from warehouse only
4. Items counted are not marked
5. Purchases and sales are not stopped during stock
count.
What matters would you consider in selecting
accounts for confirmation of receivables?
Matters to be considered in selecting accounts for
confirmation include:
• Customers with credit balances
• Large customers over a certain amount.
• Custsmers .with balances in excess of credit limits .
• Customers who have paid later invoices but have
not settled earlier invoices.
• Long outstanding balances
• Customers who do not pay against specific invoices
but make payments on account in round sums.
• Stratification
Enumerate significant points to verify allowance for
doubtful accounts.
1. Obtain age analysis.
2. Check additions of age analysis.
3. Review accuracy of the aging of balances
particularly when payments are made on account.
4. Assess reasonableness of the formula applied for
estimating allowance.
5. On a test basis, trace balances from accounts
receivable ledger to age analysis.
6. Perform analytical procedures. Compare number of
days’ sales this year with last year.
7. Check subsequent collections.
8. Check approval for allowances and write off.
9. Verify specific provisions considering
correspondence with debtors.
10. Review responses from customers for direct
confirmation.
11. Review directors’ minutes for major write off
12. Inquire about disputed invoices
13. Investigate customer balances over the credit
limit.
14. Study correspondence with customers considered
doubtful.
15. Consider if any legal proceeding have been
instituted against some customers.
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What alternative procedures can be applied if some of
the receivables cannot be directly confirmed
If the receivables cannot be confirmed, alternative
procedures may be
• Review of subsequent collections
• Inspection of invoices and delivery notes
• Analytical procedures on the aging schedule of
receivables
List four significant procedures to verify accrued
expenses
1. Obtain or prepare a schedule of accruals
2. Check subsequent payments
3. Compare with last year and investigate unusual
items or accruals which were make last year but are
not reflected in current years schedule.
4. Carry out analytical procedures where relationship
is expected to
exist.
Discuss three types of positive confirmation
Positive confirmation may be in the following form.
1. Confirmation of single transactions rather than of
entire account balance.
Customers may not always be able to confirm entire
amount balance, but may be able to confirm
individual invoice amount with total balance:
2. Request the customer to reply to the auditor in all
cases indicating the customer’s agreement with the
given information. There is risk that the customer
may reply to the confirmation request without
verifying that the information is correct. The auditor
has no way to ascertain whether this has occurred.
3. Request the customer to fill in the information
The risk that the customer replies without verification
is reduced if customer is required to fill in the amount
due. However the use of this type of confirmation
may reduce response rate.
You are the Manager on the audit of Ghazi Power
Limited (GPL), a gas transmission and distribution
company, for the year ending 31 October 2011. On
the company’s request, your firm has agreed to
complete the audit by 20 November 2011.
In order to meet the audit deadline, you are
considering various measures which include sending
requests for negative confirmations related to
balances due on 31 August 2011. On 31 August
2011, total debtors aggregated Rs. 45 million. 50% of
the amount is due from 15 major debtors, whereas the
total number of debtors is 2,450.Moreover, GPL’s
management is not allowing you to send a request for
confirmation of balance to SSO Ltd., which is among
one of the 15 major debtors, because of certain
ongoing legal disputes. Your previous experience
with the client and the results of initial risk
assessment procedures suggest that the risk of
material misstatement is low.
Required
(a) Discuss whether it would be appropriate to use the
negative
confirmations procedure in the above situation.
(b) What audit procedures should be performed at the
year end, if requests for confirmation of balances are
sent on 31 August 2011?
(c) List the procedures that should be adopted due to
management’s refusal to send a request for
conformation of balance to SSO Ltd.
(a) Certain conditions are required to be met before
an auditor can decide to use negative conformation as
a sole substantive procedure, these conditions
include:
(i) The auditor has assessed the risk of material
misstatement as low and has obtained sufficient
appropriate audit evidence regarding the operating
effectiveness of controls relevant to the assertions;
(ii) The population of items subject to negative
confirmationprocedure comprises a large number of
small, homogeneous account balances transactions or
conditions;
(iii) A very low exception rate is expected;
(iv) The auditor is not aware of circumstances or
conditions that would cause recipients of negative
confirmation requests to disregard such requests. In
the given situation, condition # (i) and (ii), are met;
the fact that risk of material misstatement is low
suggests that condition # (iii) is also being met.
Therefore it would be appropriate to use negative
conformation provided that the fourth condition is
met. For 15 major debtors, it would be appropriate to
use positive confirmation as their population consists
of small number of large balances.
(b) Audit Procedures:
(i) Prepare or obtain a client roll forward schedule
from 31 August 2011, to 31 October 2011.
(ii) Agree individual entries for 31 October 2011,
with the sales ledger and debtors control accounts.
(iii) Note and obtain explanation for any unusual
journal adjustments.
(iv) Vouch material sales or receipts with supporting
documents.
(v) Select a sample of receipts and sales and perform
tests of controls to ensure that system of internal
controls continued to operate effectively.
(vi) Re-perform cutoff test at year end.
(vii) Perform analytical procedures by comparing the
balances of debtors on 31 August 2011, to Debtors on
31 October 2011, and ascertain reasons for major
variances, if any.
viii) Check subsequent recovery of year end balances.
(c) If management refuses to allow the auditor to send
a conformation request, the auditor shall:
(i) Inquire as to management’s reason for the refusal,
and seek audit evidence as to their validity and
reasonableness;
(ii) Evaluate the implications of management’s
refusal on the auditor’s assessment of the relevant
risks of material misstatement, including the risk of
fraud, and on the nature,
timing and extent of other audit procedures;
(iii) Perform alternative audit procedures designed to
obtain relevant
and reliable audit evidence.
(iv) If the auditor concludes that:
• Management’s refusal to allow the auditor to send a
confirmation request is unreasonable;
• The auditor is unable to obtain relevant and reliable
audit evidence from alternative audit procedures the
auditor shallcommunicate with those charged with
governance and the auditor shall also determine the
implications of the results of procedures carried out
above on the audit and the auditor’s opinion.
Direct confirmations of balances due from customers
are obtained to satisfy the objective of ensuring that
the customer exists and owes the specified amount to
the company at a certain date.
Required
(a) State the circumstances in which an auditor may
decide notto circulate the requests for direct
confmnation.
(b) What are the factors that an auditor considers
while designing the requests for direct confirmation?
(c) Describe the alternative audit procedures which
may be conducted if the customer does not reply to a
request for confirmation.
(a) The auditor may consider not to circulate the
direct confirmation to the customers where:
(i) Accounts receivables are immaterial to the
financial statements; or
(ii) The response rate is not expected to be adequate;
(iii) The responses are not expected to be reliable;
(iv) Inherent and control risk in aggregate are
assessed at low level.
(v) Audit evidence expected to be gathered through
other substantive procedures (e.g. analytical
procedures) is sufficient to reduce the audit risk to an
acceptable level.
(vi) Management requests not to send the
confirmation and auditor after satisfying himself from
the reason and explanation given by the management.
(b) While designing the confirmation request, the
auditor considers the following factors:
(i) Assertions being addressed through the direct
confirmation.
(ii) Form of the external confirmation requests (i.e.
positive or negative or combination of both)
(iii) Prior experience on the audit of similar
engagements.
(iv) The nature of the information being confirmed.
(v) The intended respondent.
(vi) Type of information respondents will be able to
confirm readily.
(c) The auditor may perform one or more of the
following steps:
(i) Check receipt from customers after balance sheet
date.
(ii) When there is no receipt from customers after
balance
sheet date, the auditor should consider the following
audit procedures:
Verify validity of purchase orders, if any.
Verify goods dispatched note other documents duly
acknowledged by the customers.
(iii) Obtain explanations for invoices remaining
unpaid, if any, after subsequent one have been paid.
(iv) Examine sales near the period end to provide
audit evidence about cutoff assertion.
What steps would you take to verify bank
reconciliation?
Steps to verify bank reconciliation include:
Obtain bank reconciliation.
2 Check balances per cash book and bank statement
3 Check arithmetical accuracy.
4 Check subsequent clearance
5 Check reconciling items of the last month which
were not cleared during current month, appear on
reconciliation.
You are a part of the team on the audit of Fresh Meat
(Private) Limited which sells fresh meat products
through 25 retail outlets. Each outlet holds cash at the
year end. Sales are made on cash as well as against
credit cards. All the accounting records are
maintained at the outlets and balances with the Head
Office are reconciled on a monthly basis.
Required
List of audit assertions relevant to the audit of cash in
hand and state how you would obtain audit evidence
to support those assertions.
a) Audit Assertions
The key audit objectives in the audit of cash are to
verify the assertions of:
(i) Existence
(iii) Completeness
What matters the auditor should verify if the
company has issued shares at a premium
A company may issue shares to the public on
premium subject to the
following conditions, namely:

(a) it shall have profitable operational record of at
least one year;
(ii) the premium on public offering shall not exceed
the amount of premium charged on placements with
foreign or local institutions and the names and
addresses of such institutions shall be disclosed in the
prospectus;
(iii) the issue shall be fully underwritten and the
underwriters, not being the associated companies,
shall include at least two financial institutions,
including commercial banks and the underwriters
shall give full justification of the amount of premium
in their independent due diligence reports;
(iv) the due diligence report of the underwriters shall
form part of the
material contracts;
(v) full justification for premium shall be disclosed in
the prospectus;
(vi) the employees of the company getting
preferential allocation, if any, shall be charged
premium at the same rate as the public; and
(vii) the shares allotted to any person on account of
preferential allocation, at par, shall not be salable for
a period of two years from the date of public
subscription. These person shall be -issued jumbo
certificates with markings “not salable for two years”.
The particulars of each jumbo certificate will be
furnished to the respective stock exchange.
Companies while splitting jumbo certificates into
marketable lots, after the prescribed period, shall
inform the respective stock exchange
Your client has obtained a bank loan. You are
concerned that the client may have falsified the
accounts to meet certain debt covenants regarding
current ratio and profitability.
Discuss procedures you would apply to dispel the
doubt about such falsification.
I: The auditor should in particular verify:
• Allowance for bad debts
• Allowance for obsolete and slow moving
inventories
• Depreciation
• Deferred tax
• Provision for a loss from a law suit
• Provision for warranty claims
2. Review and test the process used by management
to develop the
above estimates
3. Use independent estimate for comparison with that
prepared b. management
4. Review subsequent events which provide evidence
of reasonableness of estimate made
5. Evaluate data and assumptions on which estimates
are based
6. Test calculations
7. Compare prior period estimates with actual
8. When there is difference between auditor’s
estimates based audit evidence and the estimated
amount in the statements, the management should be
requested to revi e estimates.
9. If the management refuses to revise the estimates,
and amounts involved are material, the auditor should
modif report.
10. The audit risk is also increased and the auditor
should co possibility of misstatement in other areas
While comparing accounts payable ledger with
suppliers’ stat
you found significant difference in the balance per
client’s b statement received from one of the supplier,
Ravi traders.
The differences were caused because
(a) Some of the invoices in the statement received
from the Ravi Traders, near year-end were not
entered in the accounts payable ledger.
(b) Certain remittances per ledger were not reflected
in the statement of account received form Ravi
Traders.
What work would you perform to adjust the
accounts?
a) For unrecorded invoices, check whether goods
were received before year-end. If the goods have
been received accrue the invoice, else ignore it.
b) For remittance in transit ascertain when the cheque
was cleared. If it is subsequently cleared within a few
days, it will appear in bank
reconciliation. If the cheque has been cleared say two
weeks after the year-end consider the possibility that
the client may not have dispatched the cheque before
year-end but recorded in the cash book. In such case
the entry should be reversed debiting bank and
crediting accounts payable.
What procedures will you apply to verify unclaimed
wages?
Procedures to verify unclaimed wages include:
1. Attend a wage pay-out
2. Obtain a copy of payroll sheet
3. Check that a pay packet is prepared for each
employee on the payroll sheet.
4. Observe that when an employee receives his pay
packet he signs for it.
5. Mark on the copy of payroll sheet the workers who
collect their pay packets.