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TUTOR:
Rules on Materiality:-
1
Item is material if it is :-
Audit Objectives:
1 1. Existence
2 2. Ownership
3 3. Completeness
4 4. Valuation
5 5. Presentation and disclosure
2
2 The accounts are prepared under the Historic cost convention. The assets
and liabilities, expenses and revenues usually shown in the accounts at
actual or original cost.
Authorization:
1
2 The authorization should be obtained before any acquisition of non current
assets or disposal of non-current assets (similar for other transactions)
Existence:
1 The asset must exist, otherwise it has been misappropriated or lost and it has
been badly maintained.
Beneficial ownership:
1 Legal ownership of assets and legal ownership of leased assets.
Accounting Standards:
3
Disclosure
o additions;
o disposals;
o acquisitions through business combinations;
o revaluation increases;
o impairment losses;
o reversals of impairment losses;
o depreciation;
o net foreign exchange differences on translation;
o other movements
4
• * The effective date of the revaluation
• * Whether an independent valuer was involved;
• * The methods and significant assumptions used in estimating fair values;
the extent to which fair values were determined directly by reference to
observable prices in an active market or recent market transactions on arm's
length terms or were estimated using other valuation techniques;
• * The carrying amount that would have been recognized had the assets been
carried under the cost model;
• * The revaluation surplus, including changes during the period and
distribution restrictions.
At each balance sheet date, review all assets to look for any indication that an asset
may be impaired (its carrying amount may be in excess of the greater of its net
selling price and its value in use).
Indications of Impairment
External sources:
Internal sources:
5
• asset is part of a restructuring or held for disposal
• worse economic performance than expected
IAS 24: Related Party Disclosures : If sale was made to related parties disclose
separately.
Event after the balance sheet date: An event, which could be favourable or
unfavourable, that occurs between the balance sheet date and the date that the
financial statements are authorised for issue.
Adjusting event: An event after the balance sheet date that provides further
evidence of conditions that existed at the balance sheet, including an event that
indicates that the going concern assumption in relation to the whole or part of the
enterprise is not appropriate.
Non-adjusting event: An event after the balance sheet date that is indicative of a
condition that arose after the balance sheet date.
6
VERIFICATION PROCEDURES (METHOD)
The non-current assets schedules will show the following and suggest the
associated verification procedures.
Opening balance:
1 Verify by reference to previous year’s balance sheet and audit files.
Acquisition:
1 * Vouch the cost of acquisition with documentary evidence.
2 * Vouch the authority for the acquisition with relevant documents (e.g.
minutes etc)
Disposal:
• * Vouch the authority for disposal
• * Examine documentation
• * Verify reasonableness of the disposal proceeds
• * Verify reasonableness of scrapping of non-current assets (e.g. scrap value)
• * Accounting policy notes.
Depreciation:
1
2 * Vouch authorization of depreciation policy
3 * Examine adequacy and appropriateness of policy
4 * Check calculations.
7
Internal control:
1 * Authorisation for Purchase and disposal
1 * Accounting and maintenance cost of assets are very relevant.
1 * The disclosure of an asset as separate items e.g. between non current and
current assets.
8
Other matters related to asset verification:
• Taxation
• Insurance
• Expert advise
1 * Check casting and compare the opening balance brought forward from
previous year.
1 * Obtain schedules of addition during the year for all classes of assets
(including intangible assets)
1 * If the non-current assets constructed using own labour check all the labour
cost is properly accounted.
1 * Verify that the original cost and accumulated depreciation have been
eliminated from non-current assets accounts.
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1 * Check calculation of profit or loss on sales and agree with profit and loss
account.
10
Investments:
Objective:
1 * The proof of ownership
2 * Gain or loss arise from the investments
3 * Appropriate method of valuation
4 * Properly disclosed in the financial statements
1 Physical examination
1 Verify the interest received and dividend received and accrued by reference
to supporting documents and published data.
11
ISA 505 External Confirmations:
Circularization of account receivables:
It is very common in the verification of account receivables is to circularise the
account receivables or some of them for direct confirmation.
Advantages:
1 Direct external evidence
Appropriate when:
1 Internal control systems is strong
Positive:
1 The customer is asked to reply whether he agrees the balance or not or is
asked to supply the balance himself. This approach is used when there is
weakness in internal control or suspicious of irregularities or numerous
bookkeeping errors is found.
12
Preferred when high assessed risk:
1 Weak internal control systems
Procedures:
1 Select samples from positive, negative balances and all customers can be
circularised stating the balance in circularization letter.
1 Letter sent on client’s note paper requesting reply to auditors and including
stamped addressed envelope to auditors’ address.
1 The auditors should follow up any legal disputes between the client and it is
customers.
2
Account receivables are the large item among the assets of most companies and
their verification is essential.
1 Sales to bona fide customers only
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1 All such sales are to approved customers
1 Once recorded the debts are only eliminated by receipts of cash or on the
authority of a responsible person
1 Balances are regularly reviewed and aged, a proper system for follow up
exists and if necessary, adequate provision for bad and doubtful debts is
made.
1 Enquire into credit balance and consider the valuation of the account
receivables.
2 Provision for bad and doubtful debts:
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The auditor should consider the following matters:
1
2 The adequacy of the system of internal control relating to the approval of
credit and following up of poor payers.
1 The state of legal proceedings and the legal status of the account receivables
e.g. in liquidation or bankruptcy
1 Is there any evidence of any debt in dispute e.g. for non-delivery, breakage,
poor quality.
Prepayments:
1
2 Obtain list of prepayments
15
1 Review the income accounts for the details of prepayments
1 Cash at bank include cash held in saving, current accounts (assets) and
cash overdrawn on current accounts (a liability)
16
Audit test:
1 Check the opening and comparative figures brought forwards and review the
previous year working papers.
1 Review activity in the nominal ledger for any unusual transaction requiring
investigation.
1 Obtain client summaries, check arithmetic and agree with nominal ledger.
1 Follow up and obtain reasons for any un-cleared items appearing in the year-
end reconciliation in the month following the year-end.
Check that cash and bank is properly classified in the balance sheet
17
Audit of Inventories
Standard: IAS 2 Inventories
Inventories include assets held for sale in the ordinary course of business (finished
goods), assets in the production process for sale in the ordinary course of business
(work in process), and materials and supplies that are consumed in production (raw
materials).
IAS 2 Does not apply to work in process arising under construction contracts. This is
covered by IAS 11 Construction Contracts.
Inventories are required to be stated at the lower of cost and net realisable value
(NRV).
Costs include:-
1. Costs of purchase (including taxes, transport, and handling) net of
trade discounts received
2. Costs of conversion (including fixed and variable manufacturing
overheads)
3. Other costs incurred in bringing the inventories to their present
location and condition
NRV is the estimated selling price in the ordinary course of business, less the
estimated cost of completion and the estimated costs necessary to make the sale.
Any write-down to NRV should be recognised as an expense in the period in which
the write-down occurs. Any reversal should be recognised in the income statement
in the period in which the reversal occurs
When inventories are sold and revenue is recognized, the carrying amount of those
inventories is recognized as an expense (often called cost-of-goods-sold). Any write-
down to NRV and any inventory losses are also recognized as an expense when
they occur.
18
Disclose:-
Auditor’s duties
1
2 The auditor must satisfy himself as to the validity of the amount attributed to
inventories and work in progress in the balance sheet.
1 Periodical counts usually undertaken at the end of the financial year of the
enterprises.
19
2 Perpetual counts is continuous count of inventories held in storage to ensure the
inventories are physically inspected to identify any slow moving items and
damaged items.
1
2
3
4
5 The key advantages of continuous counts as follows:
• Location of store
• Internal audit
• Expert advise
20
• Evaluate the client inventories counting procedures
1 Check the count of a selected number of lines and crossed reference to the
inventory records.
1 Observe and identify the obsolete, damaged and slow moving inventories.
1 To obtain copies the client’s inventories records for working paper file
1 Test the final inventories records have been properly prepared from the
count records.
21
1 Final check on pricing, casting, summaries
1 Inform the management of any problems encountered during the counts for
action in subsequent count.
Work in Progress:
1 Examine the costing systems
Audit test:
1 Reconciliation of changes in inventories (e.g. Purchases and Sales)
1 Compare the quantities of each kind of inventories held with purchase and
sales
22
The auditor’s duty:
1 Accounting policies adopted for valuing inventories
1 Test the inventory records with relevant documents such as Purchase invoice
1 Check the consistency with which the amount have been computed
VERIFICATION OF QUANTITIES
1 An entity may ascertained quantities of inventories at it is year-end either by:
23
1 It is therefore essential in any audit where inventories are material to attend
and observe the client’s counting procedures.
VERIFICATION OF VALUE
IAS 2 requires inventories should be valued at the lower of cost and net realizable
value.
Cost: All costs incurred in getting inventory to its present location and condition.
Cost of purchase:
1 In getting the inventory to its present location, the following costs will be
incurred:
1 Establish these costs with reference will be made to purchase and expense
invoices.
Cost of conversion:
1 IAS 2 states that this should be based on normal levels of activity in normal
operating condition, taking one year with another.
24
1 Conversion cost includes both direct and indirect cost incurred in converting
the raw material into finished product. These cost are allocated
systematically into product cost or unit cost.
1
2 In determining what is “normal” the following should be taken into account:
1 - Production capacity
2 - Budgeted production level
3 - Actual production level
Valuation method:
1 The IAS 2 requires the inventory valuation should be determined using the
FIFO and Weighted average method.
1 Extract from inventory records, items held longer than their normal turnover
period (slow moving)
25
1 Check with competitors’ prices
1 Discuss with management any intended sales, special offer or discounts offer
to existing customers.
1 Determine actual selling prices realised from post balance sheet receipts.
1 Check the post balance sheet cashbook or nominal ledger expense accounts
for actual selling and distribution costs.
1 Check for estimated selling and distribution etc costs and for further costs to
completion.
Disclosures:
1 By way of note to the accounts, the following disclosures should be made i.e.
proper accounting policy adopted.
26
- Finished goods x
Contract revenue should include the amount agreed in the initial contract
+ Revenue from alternations in the original contract work.
+ Claims and incentive payments that are expected to be collected and that can be
measured reliably.
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• The proportion that contract costs incurred for work performed to date bear
to the estimated total contract costs.
• Surveys of work performed
• Completion of a physical proportion of the contract work
Disclosures:
Presentation
• * The gross amount due from customers for contract work should be shown
as an asset.
•
• * The gross amount due to customers for contract work should be shown as a
liability.
28
Risk associated with holding inventories:
1
2 High level inventories held in storage resulting poor cash flow management
and financial loss for the enterprises.
29
The Audit of Payables
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THE CURRENT LIABILITIES VERIFICATION:
Audit procedures:
1 Request schedule of long and short-term liability from the
client.
Provisions:
Liability:
Contingent liability:
In reaching its best estimate, the company should take into account
the risks and uncertainties that surround the underlying events.
Expected cash outflows should be discounted to their present
values, where the effect of the time value of money is material.
Opening balance
Additions
Nature
Timing
Uncertainties
Assumptions
Reimbursement
Audit of debentures:
1
2 Obtain a schedule detailing the debentures due at the
beginning of the year, addition and redemption during the
year and final debentures at year ended.
Audit Procedures:
1 Ensure the issue within limit of Memorandum and articles of
the companies
Disclose: