INTERGRATED

AUDITING
PROBLEM
SYNTHESIS

Submitted by:

Mark Opo

BSA-IV

Submitted to:

Mr. Jaypee Y. Zoilo, MBA

Instructor

1
 TABLE OF CONTENTS

Chapter 1- Audit of Revenue and Collection Cycle………....………. 2

Chapter 2- Audit of Expenditure Cycle I………………….…..….….. 4

Chapter 3- Audit of Expenditure Cycle II…………………...……… ..8

Chapter 4- Audit of Financing and Investing Cycle…………...….… 10

Chapter 5- Substantive Test of Cash………………………….…..…. 13

Chapter 6- Substantive Test of Receivables and Sales………..……...15

Chapter 7- Substantive Test of Inventories and Cost of Goods Sold....17

Chapter 8- Substantive Test of Investments……………………….…20

Chapter 9- Substantive Test of Property and Equipment……………. 23

Chapter 10- Substantive Test of Intangible Assets……………………27

Chapter 11- Substantive Test of Liabilities……………………………30

Chapter 12- Substantive Test of Owner’s Equity Accounts…………..35

2
 Chapter 1

Audit of Revenue and Collection Cycle

Nature of Revenue Cycle

The sales and collections cycle in a business refers to the set of processes that begin

when a customer purchases goods or services and ends when your business receives

payment in full. As part of the year-end audit of your financial statements, external

accountants test sales transactions and the internal controls over those transactions to

ensure your company is not materially misstating its revenues or accounts receivable.

DOCUMENTS

 Customer’s Purchase Order

 Sales Order

 Shipping Document or Bill of Lading

 Sales Invoice

 Credit Memo

-AUDIT SIGNIFICANCE

3
 Remittance Advice

 Uncollectible Account Authorization Form

 Monthly Statement

ACCOUNTING RECORDS IN THE REVENUE AND COLLECTION CYCLE

 Sales Journal

 General Journal

Test of Controls

An auditor tests the controls you have set up for the sales cycle to determine how strong

and reliable they are. If they are strong, the auditor can reduce the amount of transaction

testing he must do. Common internal controls over the sales cycle include numbered

sales invoices, purchase order authorization over a certain limit and authorization over

receivables write-offs.

The auditor selects a random sample of transactions and examines the related purchase

orders, invoices and customer statements. If the control being tested is numbered sales

invoices, for example, the auditor ensures that all numbers in a section are accounted for

and that none are missing. If the control is that all purchase orders are approved by

management, the auditor checks for a manager's signature on each document. If control

errors are found, the auditor increases the amount of transactional testing that will be

conducted in the audit.

4
 Chapter 2

Audit of Expenditure Cycle I

NATURE OF THE EXPENDITURE CYCLE

THE MAJOR CLASSES OF TRANSACTIONS IN THIS CYCLE ARE:

 TRADING - Acquisitions, Cash Disbursements, Payroll

 MANUFATURING - Production Cycle, Inventory Warehousing Transactions

 This cycle does not include

o The acquisition of short-term or long-term securities,
o the redemption of long-term debt,
o or reacquisition of a company’s share capital.

 ACCOUNTS AFFECTED BY THE EXPENDITURE CYCLE

o Purchase requisition - Provides evidence that the purchasing

department was authorized to initiate a purchase.

o Purchase order - Contains the signature of the employee who

authorized a purchase from a vendor.

o Receiving Report - Prepared within the entity and provides evidence

that goods were received.

o Vendor’s Invoice - Created externally and provides evidence about a

purchase of goods or services.

o Debit Memo

5
 o Voucher - Provides documentation for the recording of a transaction.

o Check- Check that has been presented for payment is referred as paid or

cancelled check. Paid check provides evidence about payment that an

entity has made, such as date, payee, and amount.

o Vendor’s statement - May be used to determine that all transactions

recorded on the statements have been recorded in the books.

DOCUMENTS USED IN THE EXPENDITURE CYCLE

 Purchase requisition

 Purchase order

 Receiving Report

 Vendor’s Invoice

 Debit Memo

 Voucher

 Check

 Vendor’s statement

ACCOUNTING RECORDS INVOLVED IN THE EXPENDITURE CYCLE

 Purchase Journal
 Cash disbursement transaction file / journal
 Accounts payable master file / subsidiary ledger

6
 A. AUDIT OF ACQUISITIONS AND CASH DISBURSEMENTS

TRANSACTIONS

 TRANSACTIONS CLASSIFIED IN THE ACQUISITION AND CASH

DISURSEMENTS CYCLE FLOW:

o Processing purchase orders

o Reserving goods and services

o Recognizing the liability

o Processing and recording cash disbursements

I. SUBSTANTIVE TESTS OF TRANSACTIONS: ACQUISITIONS

AUDIT PROCEDURES

 1. Examine underlying documents for authenticity and reasonableness. Scan

voucher register for large or unusual items. Inspect acquires property, plant and

equipment. Trace inventory purchased to perpetual records. Scan voucher register

for duplicate payments.

 2. Trace a sequence of receiving reports to entries in the voucher register. Test

cutoff. Account for a sequence of entries in the voucher register.

 3. Trace from invoices to perpetual inventory records. Examine vendor’s invoices

to determine that goods were purchased.

 4. Re-compute invoices and compare invoice price to purchase order.

5. Check accuracy of accounts on invoices by reference to chart of accounts.

CASH DISBURSEMENTS TRANSACTIONS

 Typical audit procedures employed by the auditor.

7
 o 1. Prove the arithmetical accuracy of the cash disbursements record and

trace postings to the general ledger.

o 2. Compare paid bank checks with the cash disbursements records.

o 3. Account for all checks.

o 4. Reconcile recorded disbursements with the bank statement.

o 5. Examine supporting documents.

o 6. Review cash disbursements records for unusual items.

Chapter 3

Audit of Expenditure Cycle II

 I. NATURE OF PAYROLL TRANSACTIONS

Events and activities relative to executive and employee compensation.

 PRIMARY ERRORS OR IRREGULARITIES THAT MAY OCCUR

o A padded payroll

o Misappropriation of unclaimed checks

 DOCUMENTS USED IN PAYROLL AND PERSONNEL CYCLE

o Time Card

o Deduction Authorization

o Certification of Taxes

o Labor Ticket

8
 o Labor Ticket Summary

o Payroll Tax Records

o Other Personnel Records

 ACCOUNTING RECORDS IN THE PAYROLL AND PERSONNEL

CYCLE

o Payroll Register

o Employee Earnings Record

o Labor Distribution Journal

II. EVALUATION OF INTERNAL CONTROL OVER PAYROLL

TRANSACTIONS

o Methodology to be used by the auditor includes

 Inquiry

 Observation

 Review or documentation

III. SUBSTANTIVE TEST OF TRANSACTIONS: PAYROLL TRANSACTIONS

 AUDIT PROCEDURES

o 1. Check the personnel records to ascertain whether the persons paid were

actually employed during the pay period tested.

o 2. Observe actual payroll distribution.

o 3. Investigate the company’s method handling of unclaimed pay.

9
 o 4. Trace the payroll tested to summaries, trace postings of summary totals

to the general ledger and to subsidiary ledgers, and check the propriety of

the accounting distribution.

o 5. Examine the cancelled employee payroll checks for propriety. If

employees are pain in cash, examine receipts signed by them to determine

that payments have, in fact, been made to the property party.

o 6. Check the recorded pay against the original recorded of hours worked

on units produced.

Chapter 4

Audit of Financing and Investing Cycle

NATURE

 Responsibilities of planning the cash needs, raising capital, and investing funds.
 Embrace the major non-operating activities of many companies.
 Creating owners’ equity and long-term liability accounts.

FINANCING CYCLE TRANSACTIONS

1. Borrowing from others excluding open trade accounts with creditors.

 Long-term or short-term notes
 Bonds payable
 Mortgages payable
 Long-term financing leases
2. Share capital and dividend transactions.
 Share issuance
 Share reacquisition
 Share returned
 Dividend declarations

10
DOCUMENTS AND RECORDS

 Documents and records used in expenditure cycle.

 Share certificate – an engraved form showing the number of shares of share

owned by a shareholder in a corporation.

 Bond certificate – an engraved form showing the number of bonds owned by a

bondholder.
 Bond Indenture – a contract stating the terms of the bond issue between the

bondholder and the issuing entity.

 Broker’s advice – a statement form a broker specifying the details of an investing

transactions.

A. AUDITING THE FINANCING CYCLE

1. Basic Considerations

This cycle includes the sequence of procedures for authorizing, executing and

recording transactions that involve bank loans, mortgages, bonds payable and

share capital. The payments of interest and dividends are also an integral part

of the financing cycle.

Possible errors related to financing activities include the following:

 Failing to make interest accruals, or making them twice
 Accruing interest in the wrong period
 Making incorrect estimates of allowances for obligations
 Failing to recognize that the entity violated a debt agreement
 Failing to record dividends that were declared

2. Internal Control Over Financing Cycle Transactions

Accounting control objectives:

Existence or Occurrence / Rights and Obligations: Financing cycle

transactions actually occurred.

11
1. Issuance of long-term notes, bonds and share capital are made in

accordance with board of directors’ authorizations and legal requirements

and proceeds are promptly deposited intact.

2. Payments of band interest and cash dividends are made to proper payees

in accordance with board of directors or management authorizations.

3. Redemption and reacquisition with board of bonds and share capital

transactions are executed in accordance with board of directors;

authorizations.
4. Cancellation of notes when they are paid to avoid double payment.
5. Recorded balances are periodically verified with bondholders and

shareholders.

Valuation / Completeness / Classification: Financing cycle transactions are

properly valued and recorded.

1. Transactions and events are correctly recorded as to amount, classification

and accounting period.

2. Transactions are promptly and correctly posted to individual accounts.

12
 Chapter 5

Substantive Test of Cash

Substantive testing is an audit procedure that examines the financial statements and

supporting documentation to see if they contain errors. ... There are many substantive

tests that an auditor can use. The following list is a sampling of the available tests: Issue

a bank confirmation to test ending cash balances.

Substantive testing is an audit procedure that examines the financial statements and

supporting documentation to see if they contain errors. These tests are needed as

evidence to support the assertion that the financial records of an entity are complete,

valid, and accurate.

There are many substantive tests that an auditor can use. The following list is a sampling

of the available tests:

 Issue a bank confirmation to test ending cash balances

 Contact customers to confirm that accounts receivable balances are correct

 Observe the period-end physical inventory count

 Confirm the validity of inventory valuation calculations

 Confirm with experts that the fair values assigned to assets obtained through a

business combination are reasonable

 Physically match fixed assets to fixed asset records

13
 Contact suppliers to confirm that accounts payable balances are correct

 Contact lenders to confirm that loan balances are correct

 Review board of directors minutes to verify the existence of approved dividends

As indicated by the examples, substantive testing is likely to include confirmation of

account balances with third parties (such as confirming receivables), recalculating

calculations made by the client (such as valuing inventory), and observing transactions

being performed (such as the physical inventory count).

If substantive testing turns up errors or misstatements, additional audit testing may be

required. In addition, a summary of any errors found is included in a management letter

that is shared with the client's audit committee.

Substantive testing may also be conducted by a company's internal audit staff. Doing so

can provide assurance that internal recordation systems are performing as planned. If not,

the systems can be improved to eliminate the issues, thereby providing for a cleaner audit

when the external auditors conduct their tests at year-end. Internally-conducted

substantive testing may occur throughout the year.

14
 Chapter 6

Substantive Test of Receivables and Sales

In auditing accounts receivable and related revenue balances, several potential problems

exist that could create material misstatements. Some of these would be errors whereas

others would indicate fraud.

A set of basic internal control should be in place to prevent such erroneous or frauds

from happening and a serial of substantive test to be conducted by auditors to make sure

the accounts receivable’s balances are free of misstatement.

Most Common Errors and Frauds In Accounts Receivable and Revenues

Here are most common errors and frauds in accounts receivable that potentially result in

accounts receivable misstatement:

 Reported receivables and sales could be false. Amounts were recorded to manipulate

reported amount of income. False sales are especially likely if: (1) income to be

reported is down for the period, (2) employee compensation or bonuses are based on

profits, or (3) company plans to issue capital stock or borrow money in the near

future.

 Incoming cash is stolen and theft is hidden. It is done by unethical custodians by

writing off the receivable as a bad debt.

15
 Lapping is being carried out. Cash from one receivable is stolen and covered with

cash received from a second customer during the following day or two.

 The year-end cut-off of transactions is incorrect. Transactions occurring before the

end of year could be recorded in the subsequent period (thus, reporting for the initial

year is not complete).

 Transactions after the end of year could be recorded prematurely in the initial year

(reported transactions in initial year did not actually exist at the time of the financial

statements).

 Customer is billed incorrectly (because of math errors, wrong quantity, wrong price,

wrong items) or customer is just not billed at all for goods that were actually shipped

(inventory is gone but no collection is ever made).

 Transaction is with a related party so that disclosure is needed.

Chapter 7

Substantive Test of Inventories and Cost of Goods Sold

In an inventory audit, the auditor uses several analytical procedures to check the

company’s inventory methods and confirm that the financial records and actual physical

count of goods match. An inventory audit is considered a generally accepted auditing

procedure.

16
Inventory is a key asset in a company’s financial statements as it can be used as collateral

for bank loans and also can be misappropriated for fraudulent reporting purposes.

Companies typically put in place internal controls such as a custodian of inventory or a

segregation of duties between the custodian of inventory and the individual with access

to the perpetual records to reduce risks of inventory fraud and misappropriation.

Inventory is a balance sheet account and so the relevant assertions are existence, rights,

completeness, and valuation. Existence refers to whether the inventory is actually

present, rights refers to whether the company undergoing the audit actually owns the

rights to the goods, valuation refers to the correct pricing as well as any impairment

issues, and finally, completeness addresses whether all the goods that should be recorded

are fully recorded.

Inventory Audit Procedures

There are two types of substantive procedures. Substantive procedures are methods of

verifying the actual numbers on financial statements. It is different from testing of

controls, which are procedures that test the systems/policies that give rise to the numbers.

Analytical Procedures

Procedures with inventory typically include:

 A comparison of gross margin numbers with previous years

 A comparison of the inventory turnover ratio with previous years

 A comparison of the unit costs of inventory with previous years

Tests of Details of Balances

17
 Auditor observation at the inventory count

The Inventory Count – Before

Before the client performs their inventory count, the auditor will typically review the

client’s proposed policies/procedures pertaining to the inventory count. Some of these

policies typically include:

 Two-person count teams

 Pre-numbered tags and proper sequencing

 Halting the shipping and receiving of goods

 Segregation of goods that are based on consignment

 A master count sheet that is controlled only by the supervisor

The auditor will also select a sample of items, in advanced, to test on the day of the

count. The auditor will use both representative and specific item (stratification) testing

when possible.

The Inventory Count – During

 The auditor observes whether the client complies with the proposed

policies/procedures for the count – Are these procedures being performed correctly

and efficiently?

 Observe the quality and the condition of the goods – Is there any sign of

impairment/obsolescence?

18
 The auditor runs their own tests and makes note of the results. Any necessary

adjustments must be followed up to ensure that the inventory records and general

ledger reflect the adjustments.

 Obtain important cut-off information to make sure that the inventory is counting

goods that need to be counted and not counting goods that shouldn’t be counted. For

example, obtain the last 5 shipping documents and receiving reports.

The Inventory Count – After

 Match the quantities brought forward from the count to the recorded amounts on the

ledger and book any adjustments that need to be made

 Inventory must be valued at the lower of cost or market (also known as net realizable

value)

a) Cost: Calculate the unit cost of inventory again to make sure pricing is accurately

determined

b) Market: Examine subsequent sales of inventory to see if it was sold for more/less

than cost or look at the gross profit margins.

Other Inventory Audit Issues

Other issues that may arise and be of concern to an auditor include the timing of the

inventory observation. The observations usually take place at the end of October or the

end of December. Typically, due to year-end holidays and/or weather issues, inventory

observations are held in October. However, if the client is more prone to

19
fraud/manipulation and is notorious for that, auditors may show up at the end of

December to obtain more reliable data.

Another issue is whether the auditor needs to bring in a specialist or run some off-site

testing to make sure that the inventory in the warehouse is genuine. For example, for

some goods such as jewelry, grain, or other high-tech products, it is uncommon for the

regular auditor to differentiate between real and fake goods. Auditors may want to bring

in a specialist for a thorough examination or send some samples to a lab for proper

testing.

Chapter 8

Substantive Test of Investments

A substantive procedure is a process, step, or test that creates conclusive evidence

regarding the completeness, existence, disclosure, rights, or valuation (the five audit

assertions) of assets and/or accounts on the financial statements.

Most of the work auditors do is aimed at conducting substantive procedures. If you've

ever worked at an organization that has been audited by external or internal auditors, you

likely remember the requests for documentation, reports, and other original information.

20
While this may not be the most fun if you are the one being audited, it is important to

remember that the auditors are hired by someone in authority to provide an objective

assessment of the completeness, existence, disclosure, rights, or valuation of some asset

or account.

If an auditor presents such an assessment, and then ends up being wrong, they look pretty

bad. So, they don't just ask, 'Do you give receipts every time you accept cash?' Instead,

they get a copy of the detailed deposits and the receipt book and reconcile both until each

bit of cash is accounted for with an original receipt. Everyone understands that auditors

can't be absolutely sure their assessment is correct, but professional standards require

them to document sufficient evidence to provide reasonable assurance of their

conclusions.

There are many different procedures that auditors conduct that are substantive and some

they conduct that aren't substantive. Not every procedure an auditor conducts has to be

substantive; but, where non-substantive procedures are used, auditors should report the

limitations of their work.

Equity Method Overview

The equity method of accounting is used to account for an organization’s investment in

another entity (the investee). This method is only used when the investor has significant

influence over the investee. Under this method, the investor recognizes its share of the

21
profits and losses of the investee in the periods when these profits and losses are also

reflected in the accounts of the investee. Any profit or loss recognized by the investing

entity appears in its income statement. Also, any recognized profit increases the

investment recorded by the investing entity, while a recognized loss decreases the

investment.

The equity method is only used when the investor can influence the operating or

financial decisions of the investee. If there is no significant influence over the investee,

the investor instead uses the cost method to account for its investment.

Chapter 9

Substantive Test of Property and Equipment

External Auditors of most manufacturing organisations usually scope in PPE as a risk

area during their annual audit due to its materiality. A combination of controls testing and

substantive testing is usually adopted when obtaining audit assurance on PPE.

The subject matter for discussion on audit readiness this week is Property, Plant and

Equipment (PPE). This item falls within the scope of IAS 16. This standard is applicable

in accounting for property, plant and equipment, which it defines as tangible items that:

22
 Are held for use in the production or supply of goods or services, for rental to others,

or for administrative purposes

 Are expected to be used during more than one period.

The Standard excludes the following from its scope:

Property, plant and equipment classified as held for sale in accordance with IFRS 5 Non-

current Assets Held for Sale and Discontinued Operations;

 Biological assets related to agricultural activity (IAS 41 Agriculture); and

 Mineral rights and mineral reserves such as oil, natural gas and similar non-

regenerative resources.

External Auditors of most manufacturing organisations usually scope in PPE as a risk

area during their annual audit due to its materiality. A combination of controls testing and

substantive testing is usually adopted when obtaining audit assurance on PPE.

Within the business cycles selected for testing during a particular period, the principal

business activities and the sub processes are tested. The objectives for testing the sub

processes are:

Acquiring fixed assets

23
Recorded fixed asset acquisitions represent fixed assets acquired by the organization.

Fixed asset acquisitions are accurately recorded.

Fixed asset acquisitions are recorded in the appropriate period.

All fixed asset acquisitions are recorded.

The recognition criteria for property, plant and equipment are derived from the general

principles for asset recognition reflected in the Conceptual Framework for Financial

Reporting. An item of property, plant and equipment is to be recognised as an asset if,

and only if:

 It is probable that future economic benefits associated with the asset will flow to the

entity; and

 The cost of the asset to the entity can be measured reliably.

Depreciating fixed assets

Depreciation charges are valid.

Depreciation charges are accurately calculated and recorded.

All depreciation charges are recorded in the appropriate period.

Depreciation, as defined in IAS 16:6, is the systematic allocation of the depreciable

amount of an asset (i.e. the cost of the asset, or other amount substituted for cost, less its

24
residual value) over its useful life. In order to comply with the requirements of IAS 16

relating to depreciation, it is necessary to identify:

The parts (components) of each item of property, plant and equipment that are to be

depreciated separately;

 The cost or valuation of each separately depreciable component;

 The estimated residual value of each separately depreciable component;

 The length of time during which each separately depreciable component will be

commercially useful to the entity; and

 The most appropriate depreciation method for each separately depreciable

component.

Disposing of fixed assets

 Recorded fixed asset disposals represent actual disposals.

 All fixed asset disposals are recorded.

 Fixed asset disposals are accurately calculated and recorded.

 Fixed asset disposals are recorded in the appropriate period.

Derecognition

25
The Auditors may also test the application of the de-recognition policy. IAS 16 requires

that the carrying amount of an item of property, plant and equipment should be

derecognised:

 On disposal; or

 When no future economic benefits are expected from its use or disposal.

The reality is that certain organizations still include in the carrying amount of their PPE,

the value of PPE of on which future economic benefits are reasonably not expected from

their use or disposal. Their documentation and available facts do not support this

assertion.

Chapter 10

Substantive Test of Intangible Assets

The purpose of this section is to establish standards and provide guidance on auditing fair

value measurements and disclosures contained in financial statements. In particular, this

section addresses audit considerations relating to the measurement and disclosure of

assets, liabilities, and specific components of equity presented or disclosed at fair value

in financial statements. Fair value measurements of assets, liabilities, and components of

equity may arise from both the initial recording of transactions and later changes in

value. Changes in fair value measurements that occur over time may be treated in

26
different ways under generally accepted accounting principles (GAAP). For example,

GAAP may require that some fair value changes be reflected in net income and that other

fair value changes be reflected in other comprehensive income and equity.

While this section provides guidance on auditing fair value measurements and

disclosures, evidence obtained from other audit procedures also may provide evidence

relevant to the measurement and disclosure of fair values. For example, inspection

procedures to verify existence of an asset measured at fair value also may provide

relevant evidence about its valuation, such as the physical condition of the asset.

The auditor should obtain sufficient appropriate audit evidence to provide reasonable

assurance that fair value measurements and disclosures are in conformity with GAAP.

GAAP requires that certain items be measured at fair value. Financial Accounting

Standards Board (FASB) Statement of Financial Accounting Concepts No. 7, Using Cash

Flow Information and Present Value in Accounting Measurements, defines the fair value

of an asset (liability) as “the amount at which that asset (or liability) could be bought (or

incurred) or sold (or settled) in a current transaction between willing parties, that is, other

than in a forced or liquidation sale.” Although GAAP may not prescribe the method for

measuring the fair value of an item, it expresses a preference for the use of observable

market prices to make that determination. In the absence of observable market prices,

GAAP requires fair value to be based on the best information available in the

circumstances.

27
Management is responsible for making the fair value measurements and disclosures

included in the financial statements. As part of fulfilling its responsibility, management

needs to establish an accounting and financial reporting process for determining the fair

value measurements and disclosures, select appropriate valuation methods, identify and

adequately support any significant assumptions used, prepare the valuation, and ensure

that the presentation and disclosure of the fair value measurements are in accordance

with GAAP.

Fair value measurements for which observable market prices are not available are

inherently imprecise. That is because, among other things, those fair value measurements

may be based on assumptions about future conditions, transactions, or events whose

outcome is uncertain and will therefore be subject to change over time. The auditor’s

consideration of such assumptions is based on information available to the auditor at the

time of the audit. The auditor is not responsible for predicting future conditions,

transactions, or events that, had they been known at the time of the audit, may have had a

significant effect on management’s actions or management’s assumptions underlying the

fair value measurements and disclosures

Assumptions used in fair value measurements are similar in nature to those required

when developing other accounting estimates. However, if observable market prices are

not available, GAAP requires that valuation methods incorporate assumptions that

marketplace participants would use in their estimates of fair value whenever that

information is available without undue cost and effort. If information about market

28
assumptions is not available, an entity may use its own assumptions as long as there are

no contrary data indicating that marketplace participants would use different

assumptions. These concepts generally are not relevant for accounting estimates made

under measurement bases other than fair value. Section 342, Auditing Accounting

Estimates, provides guidance on auditing accounting estimates in general. This section

addresses considerations similar to those in section 342 as well as others in the specific

context of fair value measurements and disclosures in accordance with GAAP.

Chapter 11

Substantive Test of Liabilities

Test Comparative Summary

1. Obtain or prepare a comparative summary:

2. Test balances for reasonableness, fluctuations and

omissions

Test Account Detail

3. Obtain or prepare a detailed analysis
4. Perform detailed tests of the ending account balances
5. Test completeness of accrued liabilities and other
payables

Additional Procedures
6. Obtain information for disclosure

OVERVIEW-ACCRUED LIABILITIES AND OTHER PAYABLES

Accrued liabilities and other payables are considered to include those

current liabilities (other than income taxes) not covered by substantive
tests for trade accounts payable or for notes payable and long-term debt.

29
 Accrued liabilities include rent, payroll, taxes, professional fees,
etc. When designing the audit program the auditor should consider the
nature of the account balance and the risks associated with transactions
flowing through it. As with other liability accounts the auditor's primary
concern should be with the completeness objective.

When preparing this program the auditor should consider and design audit
procedures that address relevant presentation and disclosure
requirements.

AUDIT PROGRAM
ACCRUED LIABILITIES AND OTHER PAYABLES

1. Obtain or prepare a comparative summary of accrued liabilities and other payables

balances (this summary may be incorporated into the analysis in step.
2. Trace individual balances to the general ledger and previous audit's working papers.

TEST BALANCES FOR REASONABLENESS, FLUCTUATIONS AND

OMISSIONS

 Review the balances for reasonableness, expected or unexpected fluctuations

between periods and obvious omissions.

Test Account Detail

OBTAIN OR PREPARE A DETAILED ANALYSIS

3. Obtain or prepare an analysis of the detail of accrued liabilities and other payables
account balances at period-end.

The auditor should be particularly responsive to accounts involving management's

judgments and estimates; for example, judgments and estimates related to uninsured
losses and other such future liabilities.

The assessment of the control environment should be considered, particularly those

aspects dealing with management's judgments and financial statement integrity.

PERFORM DETAILED TESTS OF THE ENDING ACCOUNT BALANCES

4. By examination of documentation (e.g., payroll records, agreements,contracts,

invoices, other authorizations), recomputation, or the application of analytical
procedures, test calculation of balance at end of period.

30
ACCRUED LIABILITIES AND OTHER PAYABLES-1

The auditor normally examines documentation to test the existence of accrued liabilities
and other payables and to understand the nature and purpose of the accounts. For some
accounts it is necessary to further test by recomputation that amounts have been allocated
to the proper period or to establish their reasonableness by performing analytical
procedures.

For example, the auditor may:

a. Compare real estate tax notices with properties held.

b. Examine payroll records, payroll tax filings and subsequent cash

payments; recompute accrued payroll amounts to determine
allocation to the proper period; and review the reasonableness of
relationships among the payroll accounts when testing accrued
payroll and payroll taxes payable.

c. Review warranty agreements and prior experience and perform

analytical procedures, such as applying formulas or percentages from
prior periods to current-period revenues from products subject to
warranties, to determine the reasonableness of warranty accruals.

TEST COMPLETENESS OF ACCRUED LIABILITIES AND OTHER

PAYABLES

5. Ascertain the completeness of accrued liabilities and other payables by considering

knowledge of the division's business and prior periods' audit results, analyzing
relationships of account balances to other related accounts (e.g., payroll, real estate taxes,
commissions, professional fees, fixed assets), considering evidence from other tests (e.g.,
search for unrecorded liabilities), and considering liabilities arising out of noncompliance
with appropriate regulations.

Chapter 12
Test of Owner’s Equity Accounts

The statement of owners equity is the second report in the financial statements.

Its full name is the statement of changes in owners equity.

31
This financial report shows all the changes to the owners equity that have occurred
during the period.

These changes include:

 Capital,
 Drawings, and
 Profit or loss

Stockholders’ equity represents the claim that the corporation’s shareholders have to the
company’s net assets. As an auditor you have to account for net assets. Stockholders’
equity has three common components: paid-in capital, treasury stock, and retained
earnings.

Paid-in capital: Paid-in capital represents money that shareholders invest in a business.
There are some subcategories:

Common and preferred stock: Common and preferred stock show ownership in a
corporation. What’s the difference between the two? As the names imply, preferred stock
represents a higher rung on the ownership ladder than common stock. Common stock
represents residual ownership, which means that owners of common stock have a claim
on any remaining net assets only after preferred stockholders’ claims are paid. Because
of this characteristic of common stock, preferred stock shows traits of both debt and
equity.

Consider an example: Say that the shareholders of a fictional company (FPD) decide to
close the business. All corporate assets are sold, and the proceeds are used to pay all
remaining bills. After all the creditors are paid, the preferred stockholders get back the
money they’ve invested in the company, plus any cash dividends owed to them. Any
funds left over are then distributed to the common stockholders.

If it seems like common stockholders are treated like mud, take heart: Common
stockholders have voting rights, which preferred stockholders usually don’t have. That
means common stockholders are the ones who vote in members of the board of directors
and who vote to approve changes to the corporate charter.

Additional paid-in capital: Additional paid-in capital is the excess of what shareholders
pay to buy stock over the stock’s par value. Par value is what’s printed on the face of the
stock certificate. Additional paid-in capital is shown on the balance sheet as a component
of owner’s equity.

32
Treasury stock: Treasury stock must be recorded on the balance sheet as a contra
stockholders’ equity account. Contra accounts carry a balance opposite to the normal
balance. Because equity accounts normally have a credit balance, a contra equity account
has a debit balance.

Retained earnings: Retained earnings show a company’s total net income or loss from
the first day it’s in business to the date on the balance sheet you’re auditing.

I. Obtain or prepare a lead schedule of shareholders’ equity.

(a) Trace last year’s balances with last year’s working papers.
(b) Check arithmetical accuracy of the schedule.
(c) Trace totals of the schedule to general ledger and balance sheet. (Existence,
Obligations completeness, Valuation)

2. Test details of transactions.

(a) Check that the issued capital IS within the authorized capital of the company.
(b) In case of first issue of shares, ensure that:

Allotment of shares offered to the public for subscription, has been made only after the
amount stated in the prospectus as the minimum amount which in the opinion of the
directors must be raised by the issue of share capital has been subscribed, and the full
amount thereof has been paid to and received in cash by the company. All money
received from applicants for issue of shares are deposited and kept in a separate bank
account in a scheduled bank until certificate of commencement has been obtained. Vouch
share issue expenses such as prospectus, printing and postage, professional fee, to
invoices and cash book.

(c) Where capital is increased by the issue of further shares, check that:
Such shares are offered to the members in proportion to the existing shares held by each
member. Determine that the offer of new shares is accompanied a circular duly signed by
the directors or an officer o: company authorized by them in this behalf if prescribed
form containing material information about affairs of the company, latest statements of
the account and setting forth necessity for further capital.
Trace cash received to bank book

(d) In case of issuance of shares for consideration other than cash to determine that:

• Articles of Association permit issuance of bonus share.

• Bonus shares are issued out of free reserves built out of profits or out of share premium.
• Ensure that surplus on revaluation is not used to issue bonus shares.

33
• Bonus issue is approved by board of directors. Examine contract with the vendors.
• Check validity of services billed.
• Study board of directors minutes.
• Check disclosure in prospectus.
• If shares are issued in exchange of fixed assets, the valuation of fixed assets and the
amount of equity created by receipt of fixed assets should be verified.
• Ensure that shares issued for consideration other than cash have been separately
disclosed.

(e) If shares have been issued outside Pakistan, ensure that appropriate approvals have
been obtained. Check that the company has taken a decision within 10 days of the
closure of subscription list as to what applications have been accepted or are successful
and the money has been refunded in the case of the UN accepted or unsuccessful
applications within lO days of the date of such decision.

(g) Trace refunds made with bank statement.

(h) Inspect returns of the allotment field with the Registrar.

(i) Ensure that within 90 days after allotment of shares, and with 45 days after the
application for the registration of the transfer of any shares, the company has ready for
delivery the certificates for all shares.

j ) If shares are issued at a premium, determine that a sum equal to the aggregate amount
or the value of premium on those shares is transferred to share premium account.

(k) Check that the share premium account is not utilized to pay off dividends

(1) Where the company has issued shares at a discount ensure that: the issue of shares at
discount is authorized by resolution passed in general meeting of the company and is
sanctioned by the SECP.

The resolution has specified the maximum rate of discount, not exceeding 10% or a
higher rate fixed by the Commission, at which shares are issued. Not less than one year
has elapsed since the date on which the company was entitled to commence the business
The shares issued at discount have been issued within 60 days after the date on which the
issue is sanctioned. Every balance sheet issued by the company subsequent to the issue
of shares contains particulars of discount allowed on the issue of shares or so much of the
discount as has not been written off at the date of the issue of the balance sheet date.

3. Agree issued capital with register of members.

4. Account for all share certificates.

5. Perform analytical procedures Return on capital Earnings per share

34
6. Inspect financial statements to check that shareholders’ equin accounts have been
classified and described in accordance with International Accounting Standards
and comply with statutor; requirements.

35