Substantive Procedures Notes PDF

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Warning: TT: undefined function: 32 Warning: TT: undefined function: 32SUBSTANTIVE PROCEDURESLO # LEARN I NG OB JC T I VELO 1 TANGIBLE NON-CURRENT ASSETSLO 2 INTANGIBLE NON-CURRENT ASSETSLO 3 INVENTORYLO 4 TRADE RECEIVABLESLO 5 PREPAYMENTSLO 6 BANKLO 7 CASHLO 8 TRADE PAYABLESLO 9 ACCRUALSLO 10 PROVI...

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SUBSTANTIVE PROCEDURES LO #

LEARNING OBJCTIVE

LO 1

TANGIBLE NON-CURRENT ASSETS

LO 2

INTANGIBLE NON-CURRENT ASSETS

LO 3

INVENTORY

LO 4

TRADE RECEIVABLES

LO 5

PREPAYMENTS

LO 6

BANK

LO 7

CASH

LO 8

TRADE PAYABLES

LO 9

ACCRUALS

LO 10

PROVISIONS

LO 11

CONTINGENCIES

LO 12

NON-CURRENT LIABILITIES/LONG TERM BORROWINGS

LO 13

EQUITY

LO 14

DIRECTORS’ EMOLUMENTS

LO 15

REVENUE

LO 16

PURCHASES

LO 17

PAYROLL

LO 18

INTEREST EXPENSE AND INTEREST INCOME

LO 19

OTHER EXPENSES

LO 20

THE AUDIT OF STATUTORY BOOKS

LO 1: TANGIBLE NON-CURRENT ASSETS :

Obtain “Fixed Assets’ Schedule” and “Fixed Assets’ Register”. ➢ Cast them to ensure mathematical accuracy and agree balances with financial statements. SUBSTAN TIVE PROCEDURES FOR ADDITIONS DURIN G THE YEAR: For Purchas ed Fix ed Assets :

1. Obtain list of all fixed asset purchased during the period and agree with fixed assets’ schedule and fixed assets register (completeness and occurrence). 2. Select sample of additions and agree cost to supplier’s invoice. Also inspect invoice to verify cost does not include revenue expenses (valuation). 3. Review repair &maintenance account to verify repairs do not include capital expenditures. (completeness) 4. Inspect sale deed, purchase invoices, and legal documents as evidence of transfer of ownership in the name of company. (rights and obligation) 5. Verify existence of fixed assets acquired during the year (existence).

FOR SELF-CONSTRUCTED FIXED ASSETS:

1. Obtain list of all fixed asset constructed during the period and agree with fixed assets’ schedule and fixed assets register (completeness and occurrence). 2. Select a sample of costs and agree with supporting documentation i.e.: ▪ Site acquisition costs to purchase invoice, Transfer deed and Paid cheque. ▪ Materials (such as cement, bricks, and fittings) to suppliers’ invoice. ▪ Labour costs to approved payroll records, time sheets, etc, ▪ Overheads to relevant evidence. 3. Review the list of amounts capitalised to ensure that revenue items have not been capitalized. 4. Review expert’s assessment of stage of completion. 5. Physical inspection of the construction at the year end to confirm work to date and assess the reasonableness of stage of completion. 6. Budgeted cost should be compared with actual cost and significant differences should be investigated. 7. Borrowing cost associated with project should be recalculated to ensure its accuracy. 8. Ensure that depreciation starts as and when asset become ‘available for use’.

SUBSTANTIVE PR OCEDURES FOR DISPOSALS DURING THE YEAR:

1. Obtain list of all fixed asset disposed during the period and agree with fixed assets’ schedule and fixed assets register (Completeness and Occurrence). 2. Check that cost and accumulated depreciation has been removed from books of accounts, and fixed assets’ register. 3. Select a sample of disposals and agree Cost and Accumulated Depreciation with Fixed Assets’ Register and Sale Price with Invoice. Recalculate profit or loss recognized on disposal of assets (Accuracy).

SUBSTAN TIVE PROCEDURES FOR CLOSING BALANCE :

1. Obtain list of all fixed asset at year end and agree with fixed assets’ schedule and fixed assets register (Completeness and Occurrence). 2. Select a sample of assets from non-current assets’ register and: a. physically inspect them. (Existence). b. During physical verification, also select assets from the floor and trace them into fixed assets’ register (Completeness). c. During physical verification, also check for conditions and usage of asset for indications of impairment (Valuation). 3. If non-current assets are stated at revaluated amounts, ensure that: a. valuation is performed by a professional valuer, b. amount of valuation is reasonable, c. valuation is performed for all assets in the same class, d. valuation is regularly updated and e. valuation is appropriately accounted for in accounts. 4. Inspect sale deed, purchase invoices, and legal documents as evidence of transfer of ownership in the name of company. (rights and obligation)

SUBSTAN TIVE PROCEDURES FOR DEP RECIATION/IMPAI RMENT EXPENSE:

1. Review Fixed Assets' Register to ensure: ▪ depreciation has been charged on all depreciable fixed assets correctly. ▪ depreciation on addition starts when asset is available for use. ▪ fully depreciated assets are separately identifiable and no depreciation is charged on such assets. 2. Check whether residual value, useful life/depreciation rate, depreciation method are: ▪ reasonable (considering nature of asset), and ▪ consistent with last year and industry practice and AFRF.

3. Recalculate depreciation expense (using analytical procedures) and compare with actual expense to ensure reasonableness of depreciation expense. 4. Check whether allocation of depreciation expense between manufacturing and operating expenses is on reasonable basis. 5. Review gain or losses on disposal as indication of possible understatement or overstatement of depreciation expense. (if depreciation is reasonable, there should not be significant gain or loss)

CONCEPT REVIEW QUESTION List the audit procedures for the verification of fixed assets as appearing in the financial statements. Also give the related ‘audit assertion’ against each step. (12 marks) What are the basic assertions which the auditor would aim to address whilst carrying out the verification of fixed assets? (05 marks) Describe substantive procedures you should perform at the year end to confirm each of the following for plant and equipment: (i) Additions; and (ii)Disposals

(04 marks)

LO 2: INTANGIBLE NON-CURRENT ASSETS : PURCHASED GOODWILL:

1. Confirm from documents prepared to acquire business: a. the cost of acquisition and b. reasonableness of fair value of assets acquired. 2. Check that cost of Goodwill is difference between the cost of acquisition and fair value of net assets. 3. Review the possibility of impairment of goodwill subsequent to acquisition. If so, ensure impairment loss has been correctly calculated and recorded.

DEVELOPMENT COST:

1. Ensure that following criteria required by IAS - 38 to recognize development cost as intangible asset has been met. a. Probable future economic benefits from Intangible Asset. b. Intention to complete and use/sell Intangible Asset c. Resources (technical, financial and other) to complete and use/sell Intangible Asset are available and adequate. d. Ability to use/sell Intangible Asset. e. Technical feasibility. f. Expenditure can be reliably measured. 2. Discuss the feasibility of the project with management i.e. a. Review projects and forecasts. b. Production and marketing plans actually exist. c. Obtain representation from management regarding intention to complete the project. 3. For a sample of costs, inspect supporting documents e.g. development contracts, billing and timesheets. 4. Test controls over documentation and safekeeping of scientists’ notes, discoveries and conclusions.

OTHER INTANGIBLES:

1. Inspect legal and purchase documents to ensure existence, valuation and right of entity over intangible asset. 2. Check amortization calculation using client’s policy to ensure its accuracy (audit procedures for amortization are same as of depreciation).

3. Review the possibility of impairment subsequent to acquisition. If so, ensure impairment loss has been correctly calculated and recorded. CONCEPT REVIEW QUESTION You are the audit manager at JL. The following issue arose during the audit and now requires your attention: JL incurred an expenditure of Rs. 25 million on the development of five new products. It is expected that these new products would generate future economic benefits. Required: Comment on the matters that you should consider and state the audit evidence that you expect to be available. (06 marks)

Recommend the principal audit procedures to be performed in respect of the goodwill initially recognised on the acquisition of Canary Co. (05 marks)

LO 3: INVENTORY : Obtain “inventory lists” from client. Cast them to ensure mathematical accuracy and agree balances with financial statements. ➢ Select a sample of items from inventory lists and: physically inspect them. (Existence). During physical verification, also select assets from the floor and trace them into inventory list (Completeness). During physical verification, also check for conditions of inventory for indications of impairment (Valuation). ➢ Review reconciliation between physical balance and book balance at year end if total of listing differs with book value. (Completeness) ➢

VALUATION:

Inventory is valued at lower of Cost and NRV. 1. Cost of Raw Material will be verified by auditor as follows: ❖ Check figure of cost by comparing with prices as per purchase invoice. ❖ Recalculate the cost using approach adopted by management (e.g. FIFO or Weighted Average). 2. Cost of Work in Process and Finished Good will be verified by auditor as follows: ❖ Obtain a breakup of cost of each item of Work in Process and Manufactured Finished Good and agree the total to the general ledger. ❖ Check that correct cost and quantity of Material has been used in valuation. ❖ Check Labor cost to approved payroll records, time sheets, etc, ❖ Check only production overheads are included in the valuation (selling/admin overheads are excluded). Also check that overheads are based on normal levels of output. ❖ Review expert’s assessment of stage of completion. 3. NRV of inventory will be verified by auditor as follows: ❖ Review client’s procedures for comparing NRV with cost of each item of inventory. ❖ During physical verification, also check for conditions of obsolescence, damage indicating that NRV may be lower than Cost. ❖ Review prices at which inventory has been sold subsequent to year end as evidence of NRV. ❖ Review aged inventory reports and identify any damaged, slow moving or obsolete goods, and ensure they have been recorded at lower of Cost and NRV in Balance Sheet.

❖ Inquire management about estimated selling price of inventory, cost of completion and cost to make sale.

RIGHTS AND OBLIGATION:

1. Check inventory owned by a third party (e.g. on "consignment basis" or "approval basis") is separately identifiable, and not included in closing inventory.

PRESEN TATION AND DISCLOSURE:

1. Ensure that all disclosures as required by IAS – 2 have been included in the financial statements. 2. Review that disclosures in the financial statements are correct and clear.

AUDIT PROCEDURES/RESPONSIBILITIES BEFORE, DURING AND AFTER INVENTORY COUNT: Before Inventory count (i.e. Planning) ➢Review client’s instruction for inventory (discussed in previous chapter) count to assess effectiveness of count. ➢Determine if any inventory is held by third parties to assess need to send confirmation letter. ➢Determine whether there is need of an expert or component auditor. ➢Decide which counts locations will be observed by audit team.

During inventory count (i.e. Observing and Recording) ✓ Observe the count to ensure that management’s instructions are being followed.

After inventory count (i.e. Follow up) ❖ Ensure quantity of valuation match inventory list.

✓ Perform test count by checking items from inventory sheet to warehouse and vice-versa.

❖ Inspect aging of inventory to identify slow moving and obsolete stock and discuss provisioning with management.

✓ Observe conditions of inventory for possible NRV adjustment. ✓ Ensure that inventory belonging to third parties but held by client is segregated. ✓ Perform cutoff test on sales and purchases. ✓ Obtain signed copies of count sheets from client.

final with

❖ Ensure that inventory is valued at lower of cost and NRV. ❖ Ensure that Cutoff procedures have been appropriately applied while recording sales and purchases.

CONCEPT REVIEW QUESTION List the substantive procedures that may be performed by the auditor to verify the amount of inventories as appearing in the financial statements of a manufacturing concern. (15 marks)

You have been asked by your senior to observe the stock count at one of the audit clients: (a) What procedures would you perform prior to the physical count to ensure a smooth stock count?

(04 marks)

(b) During the stock count, how would you ensure that the physical inventory listing provided to you is complete? (04 marks)

How does the auditor deal with the situation when inventory is found under the custody and control of a third party ? Include in your answer the considerations which the auditor is likely to take into account in this regard. (05 marks)

(i) Identify and explain FOUR financial statement assertions relevant to account balances at the year end; and (ii) For each identified assertion, describe a substantive procedure relevant to the audit of year-end inventory. (08 marks)

The management of Redburn Co have told you that inventory is correctly valued at the lower of cost and net realisable value. You have already satisfied yourself that cost is correctly determined. Required: (i) Define net realisable value;

(02 marks)

(ii) State and explain the purpose of FOUR procedures that you should use to ensure that net realisable value of the inventory is at or above cost. (08 marks)

LO 4: TRADE RECEIVABLES : EXISTENCE, COMPLETENESS, AND RIGHTS AN D OBLIGATION:

1. Obtain a listing of trade receivables from the sales ledger. Cast it and agree to the control account and financial statements. Review reconciliation between control account and sales ledger if difference exists. 2. Calculate debtors’ turnover ratio and compare with prior years. Investigate any significant differences. 3. Review the list of trade receivables against prior years to identify any significant variations/omissions. 4. Select a sample of debtors from sales ledger at year end and perform a trade receivables’ circularization (i.e. direct confirmation). Perform alternative audit procedures in case of nonresponse and additional audit procedures in case of exceptions identified. 5. Select a sample of debtors from sales ledger at year end and agree back to valid supporting documentations of GDN and Sales orders. 6. Review whether effect of cut-off on sales have been appropriately accounted for in debtors. 7. Review the control account entries shortly before and after the year end for unusual items and investigate them. 8. Review cash receipts after year end and trace to debtors at year end. 9. Review credit notes after year end to identify any sales transactions before year end which should be reversed.

EVALUATE ADE QUACY OF PRO VISION FOR BAD DEBTS:

a) Inquire management regarding estimates used in calculation of provision for bad debts. b) Obtain aged receivable ledger. Compare it with control account and test the aging. Review the aged receivable ledger to identify any slow moving or old receivable balances. Discuss the status with the management to assess whether they are likely to pay. c) Examine whether there are any cash recovery of doubtful debts or bankruptcy after balance sheet date. d) For large overdue balances, review financial statements of debtors and discuss with management likelihood of their collection. e) Recalculate provision for bad-debts using sales, write-offs and current economic conditions of customers. f) Inquire management about any disputes with customers and review board minutes for disputed receivables. g) Review communication of client with customers, lawyers and collection agencies regarding debts which are in dispute or unlikely to be paid.

FOR PRESENTATION & DISCLOSURES:

▪ ▪ ▪

Determine if any receivables have been pledged, discounted, factored. Inquire about receivables from officers, directors or other related parties. Ensure that receivables are correctly disclosed and classified in financial statements.

CONCEPT REVIEW QUESTION You are the senior member of the audit engagement team, auditing the financial statements of a manufacturing company, Hard Stone Limited. List down the primary substantive procedures, which you would carry out in the verification of trade debts (excluding receipts from customers). (06 marks) List down any five (05) key audit procedures for verification of provisions against doubtful receivables.

(05 marks)

LO 5: PREPAYMENTS : ➢ Obtain a schedule of all prepayments. Cast list to ensure mathematical accuracy and agree balances with financial statements. ➢ Nature and amount of all prepayments should be compared with prior periods. ➢ For sample of prepayments, recalculate their amounts with supporting documents and payment from bank statement. ➢ Agree prepayments to the adjustments after the end of the year. LO 6: BANK: 1. Obtain a list of all bank accounts (including accounts closed during the year) along with closing balances. Cast list to ensure mathematical accuracy and agree balances with financial statements. 2. Obtain bank confirmation letter for all bank accounts (including accounts closed during the year) and perform following procedures: ▪ Agree balances as per bank confirmation letter with bank reconciliation statements (accuracy) and with list of bank accounts (completeness). ▪ Confirmation should be reviewed for evidence of loans, collateral or any lien/restriction on balance. 3. Obtain Bank Reconciliation Statements (BRS) for each bank account and perform following procedures: ▪ Cast BRS to ensure mathematical accuracy and agree balances of BRS with bank statement and cash book. ▪ Trace deposits in transit into deposit slips and cash book of current month; and in bank statement of subsequent month. For significant delays inquire explanation from management. ▪ trace unpresented cheques into cash book of current month; and in bank statement of subsequent month. For significant delays inquire explanation from management. ▪ for untraced items examine supporting documentation. 4. Perform cutoff test on cheque receipts and cheque payments.

5. Review cash book and bank statement for large transfers near year-end - window-dressing. CONCEPT REVIEW QUESTION List the substantive procedures that may be performed by an auditor to verify Bank reconciliation statements. (06 marks) Describe substantive procedures the auditor should perform to confirm the bank and cash balance of Fox Industries Co at the year end. (07 marks)

List down at least five audit procedures undertaken by the auditor in respect of the following: (i) Bank reconciliation statements

(05 marks)

(ii)Bank confirmations

(05 marks)

LO 7: CASH: ➢ Perform cash count at year end (including petty cash) and agree the total to the balance includes in financial statements. ➢ Review reconciliation for difference between book balance and physical balance. ➢ Perform cutoff test on cash receipts and cash payments. ➢ Ensure cash is under proper lock and key, and in safe custody.

CONCEPT REVIEW QUESTION 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 t...