Auditing and assurance revision question and answer

Auditing and Assurance Revision Questions and Answers

Company A has a number of long and short-term payables, accruals and provisions in its balance sheet.
Required:

Describe the audit procedures you would apply to each of the three items listed below, including those relating to disclosure.

i) A 10-year bank loan with a variable interest rate and an overdraft both from the same bank. (5 marks)
ii) Expense accruals. (4 marks)
iii) Trade payables and purchase accruals. (6 marks)

(b) Company B has a provision in its balance sheet for claims made customers for product defects under 1-year company warranties.

Required:
Describe the matters you would consider and the audit evidence you would require for the provision. (5 marks)
(Total: 20 marks)

ANSWER
(a) Company A

(i) 10-year bank loan and bank overdraft

 Authorization for the loan and overdraft should be checked to the minutes of a board or other relevant meeting.

 The details of contracts with the bank and any relevant correspondence should be examined. Any covenants restricting the use of securities held against the loans should be examined and the client‘s compliance with the covenant checked. If covenants have not been complied with, the implications for the company and the financial statements should be considered.

 The response to the year-end bank confirmation should be examined. It should provide details of the amounts outstanding and the amounts paid and payable during the year in terms of both interest (loan and overdraft) and capital (loan only). In both cases, details of any security held for the loan and overdraft should be requested.

 Analytical procedures should be applied to the interest paid in the income statement, and to the interest and capital paid and outstanding at the period-end for the loan.

 The bank reconciliation should be checked to ensure that the overdraft has been properly reconciled to the records, and that there are no old or significant outstanding amounts that need to be adjusted for.

 The amount payable at the year-end should include amounts payable in one year, which should be included in current payables, and amounts payable in over one year. The notes to the financial statements should also disclose amounts payable in over five years.

 The auditors should ensure that appropriate disclosures are made in the notes to the accounts in accordance with legislation and International Financial Reporting Standards. In particular, where assets are held as security, this should be disclosed in the notes relating to the assets.

(ii) Expense accruals

 If accruals are material to the financial statements, more evidence will be required than if they are not. If accruals are not material, analytical procedures may be sufficient audit evidence;

 A schedule of accruals should be obtained and checked for arithmetical accuracy. Individual accruals should be reviewed comparison with prior periods and budgets and any significant variations investigated, particularly if accruals have been made in previous periods but have not been made in the current period;

 The amounts paid after the period-end should be checked to the bank statement and the calculation of a sample of amounts payable should be checked for accuracy, reference to subsequent invoices;

 If any accruals are payable more than one year after the balance sheet date, an appropriate split should be made in the balance sheet.

(iii) Trade payables and purchase accruals

 The nature and extent of testing will depend on the quality of controls over trade payables, as evidenced interim testing of internal controls. Evidence in relation to the completeness of trade payables and accruals is important, but not always easy to obtain;

 The auditors should form an opinion as to whether direct confirmation of trade payables is likely to provide valuable audit evidence discussion with the client.

 It is sometimes possible to rely on supplier statement reconciliations instead of direct confirmation, but this depends on the availability of supplier statements. Where supplier statement reconciliations are performed, it is important to be aware of the possibility of forged or altered statements – originals rather than copies should be examined. Some combination of supplier statement reconciliations and direct confirmation is often used.

 

 If a decision to obtain direct confirmation of trade payables is taken, the client‘s co- operation is required in authorising the requests and in helping the auditors sort out any differences between the balances recorded the company and those recorded suppliers.

 Particular care should be taken if there are material balances for which there are no supplier statements or no response to a request for confirmation. Consideration should be given to telephoning the supplier in this case.

 Analytical procedures should be applied to the ageing and level of trade payables comparison with prior periods;

 Variations should be investigated and substantiated, with particular attention being paid to old outstanding amounts;

 A representative sample of individual trade payables should be traced back through the system from the schedules supporting the financial statements to the ledgers, daybooks and source documentation to ensure that the amounts recorded are accurate. The size of the sample will depend on the auditor‘s assessment of risk in this area;

 A schedule of purchase accruals should be obtained and checked for arithmetical accuracy and completeness comparison with prior periods and invoices received after the period-end. As with trade payables generally, there is a risk of unrecorded items.

 Both trade payables and purchase accruals should be tested for the accuracy of cut-off reference to invoices and inventory records for an appropriate period each side of the period-end;

 A review of correspondence with trade creditors should be performed and any legal department should be requested to provide details of disputes with creditors;

 If any trade payables are payable more than one year after the balance sheet date, an appropriate split should be made in the balance sheet.

(b) Company B

(i) Provisions for manufacturing warranty claims are heavily dependent on the judgement of directors. The auditors should establish how the directors have arrived at the provision and assess it for reasonableness in the light of previous provisions and claims. More work will be required if there has been a significant discrepancy between provisions and claims in the past and more work will be required if the company does not have significant experience in dealing with this type of warranty claim.
(ii) IAS 37 ‗Provisions, Contingent Liabilities and Contingent Assets‘ states that a provision is a liability of uncertain timing or amount which should only be recognised when there is a present obligation, as a result of a past event, and where it is probable that an outflow of resources will be required to settle the obligation, the amount of which can be reliably estimated. It would appear that the warranty claim fits this description.

(iv) Auditors should check the calculation of the provision for arithmetical accuracy and to ensure that it is calculated in accordance with the method determined directors. This can be achieved reviewing the level of claims and payments both before and after the period-end.

(v) If there has been a change in the method of calculating the provision, the auditors should ensure that it is reasonable in the light of evidence available and that it is properly disclosed, if material. If there has been a change in the product mix to which the warranty applies, this should also be considered, particularly if there are new, relatively untried products which carry a higher risk of claims in the first few years.

(vi) If any previous provisions have been released in the current period because of over- provisions in previous periods, the auditors should ensure that the amount released is reasonable, and is properly disclosed in the income statement as appropriate. ‗Soft‘

provisions such as these can be manipulated the client and particular care therefore needs to be taken.

(vii) A review of correspondence with customers should be performed and any legal department should be requested to provide details of disputes with customers relating to claims.



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