Auditing Investment: Assertions, Risks, and Key Procedures

Meaning of Investments

Investment is the deployment of capital in order to earn interest, dividend, or capital appreciation. Investments are basically either held to maturity or available for sale securities. Held to maturity securities are those that are held with intent until maturity.

These are reported at cost, provided for amortization and accretion of discounts. Available for sale investments are reported at fair value where any unrealized profits or losses form part of stockholders’ equity.

While auditing the investment of any entity, the auditor needs to be aware of applicable accounting guidance. They should be familiar with the knowledge of client business and the nature of investment it holds.

Audit assertions for Investments

Investments are audited by testing various audit assertions as existence, completeness, valuation, and rights and obligations. These are explained in detail below:

ExistenceInspecting investment securities on hand and comparing with previous year balances and accounts along with purchases and sales in the current year. This also takes into the movement of cash from and towards the investment
ValuationExamining financial statements to check recognition of gains or losses from investment. This also would mean checking carrying amounts of securities under the equity method
CompletenessThe investments have been completely recorded with respect to interest, dividends and fair value, if applied.
Rights and obligationsChecking and verifying that the client has ownership rights for investments on the date of balance sheet.
Presentation and disclosureVerifying that all investments have been properly classified and notes have been placed with respect to restrictions in investments.

Primary risks for Investments

The inherent risk and control risk in the obligations form the risk of material misstatement in investment reporting and compliance. The risk of being susceptible to misstatement due to the nature of the investment is the inherent risk of the investment.

Control risk occurs when the internal control system of the auditee fails to prevent or detect material misstatement in the investment. The inherent risk further involves issues related to existence and valuation of investment on books.

When the value of investment is overstated, there is higher risk it could be due to fraud with intention. The investment of the client may come with certain restriction which have not been disclosed and circumstances would lead to non-detection of such restriction.

These are where internal control fails due to complexity of terms and conditions in arrangements of investments being done.

The various other risks for investments would include:

  1. Investments are intentionally overstated to cover up fraud
  2. Investments are not correctly valued due to complexity and management’s lack of accounting knowledge
  3. Misstatement of investment with improper cut-off
  4. Proper disclosures not made with respect to investments.

Substantive audit procedures for investment

Auditing investment requires a deep working knowledge of accounting and auditing standards along with knowledge of client business and the type of investments they hold.

The substantive audit procedures related to investments should respond to risks identified by the management and auditors which involves confirmation of investments, an inspection of cut off of investment with respect to date and amount, and vetting the investment documents for the requirements related to disclosure and checklists.

It would better to show the audit assertions and relevant substantive audit procedures carried out for such assertions as:

Audit AssertionsSubstantive audit procedures
ExistenceBalance confirmation from broker company in respect of securities held. Inspecting the investments that are tangible physically. Vouching and verification of all the purchases and disposals of the investments.
ValuationVerifying that investment balances reflect market values at the reporting date, if applicable. Re-computation of interest and dividends Determining if gains and losses have been properly recorded
CompletenessChecking arithmetic accuracy of the schedule by footing and cross-footingPreparing and verifying the balances with reconciliation of investment balances from previous year.Verifying that all investment related transactions have been recorded in the proper accounting period.
Rights and obligationsInquiring the management on restrictions if any on investment studying the terms and conditions of investments and checking if they have complied.
Presentation and disclosureVerifying that if any restrictions have been placed on investments are properly disclosed in the notes to accounts. Verifying that investments have been properly classified and reported.

Search for unrecorded liabilities

Meaning for the search for unrecorded liabilities

Search for unrecorded liabilities is the audit testing procedures that auditors perform to verify if the liabilities are understated by completely not recording it. Such tests of the search for unrecorded liabilities is performed by auditors to give an appropriate response to assess the risk of understatement of liabilities.

In industrial environment, search of unrecorded assets like searching for debtors or accounts receivable as being unrecorded is very unlikely than as to search for unrecorded liabilities like accounts payable or notes payable.

The reason is that management of the company normally intend to understate the liabilities or expenses rather than the understat assets or revenues. Since these are the key financial figure that link their performance.

This would mean that liabilities have more risk of being unrecorded than the accounts of asset. Auditors shall perform audit procedures for search for unrecorded liabilities in order to test completeness aspects of all the liabilities of books of account. This also helps to determine if liabilities shall be excluded or included from the current accounting period.

Examples of Search for Unrecorded liabilities

Here, we discuss what audit procedures need to be followed to search for two liabilities i.e. accounts payable and notes payable as:

In case of accounts payable, audit procedure is performed to test completeness assertion through following steps:

  1. First, samples are selected of transactions that are made after closing of books of account
  2. The auditor then proceeds to examine the sample payments by making verification with document evidence and assess if the liabilities existed on the date of balance sheet.
  3. The auditor also inquires with appropriate personnel on any unrecorded invoices.

In audit using sample, the risk of material misstatement is directly proportional to the selection of sample size. Hence, the auditor needs to exercise his professional judgement and competence. If risk of material misstatement is assessed as high by the auditor, the sample size selection should be enlarged and the auditor shall try to reduce the risk to an acceptable level.

The audit procedures in case of notes payable is similar to that of accounts payable. As it happens, the notes payable has large sum involved and hence, the risk of material misstatement in case of notes payable increases massively.

Substantive audit procedures need to be performed in case of notes payable. The auditor needs to confirm the existence and year end balances by making direct confirmation from the third parties. Further, the auditors should analyze board meetings minutes for authorization of debts and check if any debts have been unrecorded as such.

Audit Procedures to search for unrecorded liabilities.

Auditor should verify the unrecorded liability by applying the given audit procedures:

  • The auditor shall verify purchase orders and all supporting documents with journal entries related to purchases and cash disbursals. This helps the auditor to assess if purchases have been properly recorded and with the correct amount.
  • Analytical procedures are done in order to test the trend and look for unusual relations. The various accounting ratios as accounts payable turnover is important in the search for unrecorded liabilities. All the unusual relations shall be properly investigated by the auditor. While auditing accounts payables and looking for unrecorded portions, the auditor would need to look at cash disbursals after the year-end and verify they have been properly recorded as payables at the end of the year.
  • The auditor shall audit and test all the audit trails leading the payments to liabilities that have been recorded. This can be done for payables that exist on the year-end balance sheet date. The auditor can clearly state that if cheques that cannot be matched to recorded payables would amount to unrecorded liability at year-end.
  • The auditor shall carefully examine all the cash disbursements using the Cash disbursements cutoff test. This would help to reconcile the cash disbursements and accounts payable. The auditor shall also inspect the cheques issued and trace them to ledgers of accounts payable. Doing so would help the auditor to detect items that have been purchased before the end of the year but not recorded i.e. unrecorded accounts payables.
  • In case the company employs a voucher system, all the requisition, receipts, and suppliers’ invoices shall be reconciled with purchase orders. The auditors should therefore in such companies employing voucher system, vouch for samples of invoices related to cash disbursals after the end of the year and compare with all the receipt reports and suppliers’ invoices. This helps the auditors to search for unmatched documents.
  • The audit can also make direct confirmation from the vendors regardless of the balance dues at the end of the year.

What is journaling entry testing? Why it is important?

Journaling entry testing:

The need for journal entry testing arises when the auditor needs to test the nature, timing, and extent of journal entries. It is done to recognize the risk of material misstatement due to fraud while recording financial transactions.

The auditor should be vigil in its audit of transactions and should look at all the transactions of suspicious nature. The auditor should verify all the transactions with the supporting documents and all the entries should be duly authorized by higher authority after accountant records the transactions.

During audit, the auditor usually tests the sample transactions by following substantive procedures. He verifies the authenticity, validity, accuracy of the transactions.

During this procedure he may cross check the journal entries with the supporting documents, vouchers. Journal entry testing is carried out to have a proper understanding of the internal control system of the company.

 This testing also reflects on the compliance procedures adopted by the company in dealing with the established rules and standards of accounting and auditing.

Journal entries are prepared by the accountants so this testing should involve the inquiries of management and other staffs including the internal auditors about the risks of fraud. Journal entry testing is carried out by the auditors who audit the financial transactions of the company.

Else the testing can be done for external requirements when a court or government orders a probe into the financial transactions of the company due to financial misconduct, fraud, and negligence.

Importance of Journal Entry Testing:

  • Data analysis in audits: Audit testing is carried out to gather sufficient and appropriate audit evidence. Without testing journal entries, the professional requirement for documentation and test of efficiency and effectiveness of the internal control system cannot be carried out. Data analysis has become a wide field to recognize the trend and is necessary for the success of the enterprise.
  • Maintains quality and efficiency: The volume of data used in companies is increasing manifold. These transactions are recorded in accounting packages. Hence it helps to increase the authenticity, validity, and accuracy of the transactions.  The journal entry testing ensures that all the postings are done in line with standards set by the organization and following all the audit and accounting standards.
  • Detects misstatements including fraud: This testing is done on sample entries and if any suspicion arises on such entries, the auditor goes through extensive audit procedures viz. compliance and substantive procedures to detect misstatements and frauds. The frauds when detected during journal entries testing mean that auditors need to expand their audit sample and, in some cases, extend to the whole of the population.
  • Test the appropriateness of the entries made: This testing is carried out to know whether the entries are authorized by the higher authority and the proper backing of such entries is available.
  • Test the existence, working of internal control system: Journal entry testing helps in detecting the existence, the efficiency of the internal control system. When the internal control system is functioning properly, the frauds cannot go unnoticed and it can be detected by maker and checker policy. Maker and checker policy basically mean a dual way of preparation of any accounting records and verification of the same by another accounting staff preferably of higher authority and qualification.
  • Used as evidence during forensic audits: When forensic audits are carried out to unearth the frauds in a company, journal entry testing can be used as evidence by the investigating agencies in trial proceedings. When it has been established in the journal entry testing that internal controls have been good, forensic audits can be conducted thoroughly and effectively and in line with guidance.
  • Helps to detect the inappropriate financial assertions: Financial assertions include completeness, cut-off, accuracy, occurrence, and classification. So, the recorded expense transactions should pass the above tests. When any lapses occur in relation to the above criteria, journal entry testing can trace those errors. The accountants may make mistakes as a result of ignorance or due to low knowledge of such aspects. Hence, the journal testing would help to remove such assertions but after the entries have been made.
  • Protects the company and its stakeholders from impacts of fraud: This testing helps to detect the lacunae in the internal control system and frauds in the accounting of the financial transactions. If frauds are detected at an early stage, the reputation of the company still remains intact. How it deals with these circumstances also ensures the survival and brand reputation of the organization.
Audit Expenses: Assertions, Risks and Procedures

Audit Expenses: Assertions, Risks and Procedures

Meaning of expenses

Expenses depict a decrease in economic benefits for the accounting period. Expenses are in the form of outflows of assets or payments of operating liabilities which results in a decrease in equity. This is other than those relating to distributions to equity shareholders.

Expenses are reduced from the revenues in order to arrive at the net profit for the accounting period. Expenses include utilities, office supplies, transportation, professional fees, consulting fees, and insurance.

In financial statements, expenses are sometimes called general and administrative expenses or operating expenses. They are recorded only in the income statement in the expenses section. They are not shown in other statements like balance sheet, statement of change in equity, or statement of cash flow.

Here, we will discuss the overall audit procedures for expenses that normally perform by auditors, key audit assertion used by management to records the expenses, and test by auditor.

Audit Assertions for Expenses

Audit of expenses can be done by testing various audit assertions of completeness, accuracy, occurrence, and cut-off. Audit procedures are relevant to gather appropriate audit evidence in order to make a conclusion with regards to expenses.

The understatement of expenses will make look financial statements better than it is. Therefore, the auditors shall primarily look at such cases of an understatement. In the case of auditing expenses, the most important aspect is the completeness of records in the income statement.

The lack of strong internal controls will lead to an understatement of expenses. This usually happens due to fraud committed by the internal staff. Near the end of the reporting date, the management may try to delay incurring expenses in order to avoid getting the expenses being reported. Hence, they might do this by recording in the next accounting period and avoiding the current. This is simply understating the profits and need to be checked by the auditors.

Here are the key audit assertions to test the assertions:

CompletenessThe expenses have been incurred are complete records and timely recorded up to date of reporting
Cut-offThe expenses have been differentiated as per the accrual system and recorded in the proper accounting period.
AccuracyThe expenses are recorded accurately for the amount
OccurrenceThe expenses have been actually incurred and related to the business.
ClassificationThe expenses have been properly classified as factory, administration and selling expenses if necessary.

Risk of Material Misstatement for Expenses

The primary risk of material misstatement is the risk that internal control may not able to detect or prevent the issues related to procedures that are inherent. It is the combination of both inherent risk and control risk.

The risk of being susceptible to misstatement due to the nature of the debt is the inherent risk of the debt. Control risk occurs when the internal control system of the auditee fails to prevent or detect material misstatement in the debt.

The primary inherent risk would be the understatement of expenses. This would lead to over-reporting the profits in the current accounting period. This happens when incentives are linked to profit or as result of intense pressure from within the company.

Take, for instance, branch managers are given a 5% incentive bonus as a percentage of profit if a certain business is achieved. In this case, the branch manager would try to overstate profit by underreporting the profits due to the inherent structure of the incentive.

The varieties of inherent risks that may occur in the audit of expenses are as follows:

  1. The expenses have been accrued, not recorded and not yet paid.
  2. The expenses are recorded as asset to understate the expenses and overstate the asset. Take for an instance, installation of newly purchased machinery.
  3. The general repairs and maintenance expenses are added to the cost of fixed assets.
  4. Changing the accounting period to close books early. This has although happened very rarely.
  5. Breaking down the large expenses into smaller ones to avoid checks and cut-off procedures employed by the auditors.

The varieties of control risks that may occur in the audit of expenses are as follows:

  1. Dividing duties among various staffs to make purchases, receive goods and proper accounting in the system.
  2. Proper authorization on all expenses and payment
  3. Matching the purchase invoice with amount of goods received along with transportation invoice.

Take for example, in case no authorization control is employed, the risk that expenses have been incurred for fictitious or personal purposes increase.

Substantive Audit Procedures for Expenses

In the case of expenses, substantive audit procedures would include substantive analytical procedures and tests of details. Analytical procedures mean gathering the audit evidence with respect to audit assertions. The accounting trends, financial ratios, and relationships among data are analyzed in such a procedure. Following are some substantive audit procedures to be followed while auditing expenses:

  1. Obtain all the supporting documents such as invoices, voucher slips, etc for the expense being incurred
  2. Perform further audit procedures when expenses reach the amount above the budget threshold significantly (by more than 10%)
  3. Check whether proper authorization has been done with regard to expenses.
  4. Verify that vendors exist through third party confirmation and making surprise visits when goods are received and auditing goods received a note with the physical purchase being received.
  5. Ensure that proper classification has been made for expenses with respect to revenue expenditure and capital expenditure.
  6. Verify the related party expenses and ensure they are being reported with notes to financial statements where necessary.

Audit debt: Assertions, Risks, and Procedures

Auditing Debt

Debt is simply liabilities, the amount the company owes to someone. Auditing of debt requires an understanding of complex debt instruments, classification of debt as per covenants, and characteristics of debt. In the financial statements, debit balance at the reporting date is reporting the balance sheet under current or non-current liabilities depending on the maturity of the debt.

The debts such as detachable warrants have equity features that can lead to various complications. There are transactions like a lease that ends up creating debt even if the intention is completely different.

Organizations all big or small deal in debts in some form or other. Debt forms major part of total liabilities.

The balances of debt need checks of rigid internal control systems employed by the management of the company, extensive substantive procedures wherever necessary, and since it is related to an outside party, balance confirmation through books and from the party.

In this article, we are going to discuss certain areas related to the auditing of debt which including the general risks of material misstatements related to the debt, assets assertion to test the existence and valuation of debt, and the interest calculation. We will also discuss the substantive procedures that auditors normally performs to test or audit debt in the financial statements.

Debt Assertions

The relevant debt assertions related to debt are completeness, classification, and obligation. Completeness and classification are prioritized by auditors in general.

The balances of debt on the balance sheet would mean that the requirements related to debt is complete and it is being classified correctly.

Classification of debt would mean the differentiation between long- and short-term debt. Further, the transaction also needs assurance regarding whether the debt is involved and not equity through the features. Debt is the obligation of the entity that is being audited.

CompletenessThis states that all the debt obligations have been recorded properly.
ExistenceOn the date of balance sheet, all the obligations of the company have been reported.
ValuationThe balances of the debt accounts correctly reflect the actual economic value.
Rights and obligationThe company owes a sum of money on the date of reporting of the balance sheet.
Presentation and disclosureDebts are correctly classified into current and non-current liabilities as per applicable accounting standards.

Visualization of debt is necessary to understand the assertions that need to be checked. The visualization of debt also checks if any internal control weakness exists. The following are the questions to be asked while visualizing the debt:

  1. Documents to inspect
  2. Existence of debt covenants and violations, if any
  3. Nature of violations
  4. Preparation of amortization schedules.
  5. Line of credit available to the company
  6. Inspection of loan documents.
  7. Refinancing debt
  8. Existence of sinking funds
  9. Reconciliation of debt in the general ledger to the loan amortization schedule

Further, in case of the existence of weakness in control, the auditors must create substantive audit procedures to address the issue. Take, for instance, the person has been made responsible is same for loan documentation and reconciliation. There is no scope of verification and double-checking. In this case, the auditors shall perform substantive audit procedures related to fraud.

Major debt risks

This would include the following:

  1. Understatement or omitting of debt
  2. Wrong classification of debt i.e. non-current liabilities recorded as current as on the balance sheet date.

The company would always want to understate its risk if it’s unethical. It can wrongly classify current debt as non-current debt to make the balance sheets look healthier on the outside. The company’s working capital ratio in such a scenario improves and then the company can get an additional loan on this basis.

Risk of Material Misstatement in Audit of Debt

The inherent risk and control risk in the obligations form the risk of material misstatement in debt. The risk of being susceptible to misstatement due to the nature of the debt is the inherent risk of the debt. Control risk occurs when the internal control system of the auditee fails to prevent or detect material misstatement in the debt.

To name some risks, unauthorized transactions, wrong recording of debt and non-confirmation with debt accounting standards are material misstatements.

An unauthorized transaction is a case where someone other than the person authorized and responsible for debt-related affairs deals with the debt matters either within the entity or with the outsiders. Such risks generally create the risk of fraud which is itself material misstatement. The audit client shall correctly record debt as per applicable accounting standards.

The proper classification shall be done. Further, the breach of debt covenants also leads to material misstatements. Hence, the auditor needs to clearly understand the borrowing arrangements and check if they are complied in time and in full.

Substantive Procedures for Debt:

The general substantive procedures are followed if the auditor decides in the light of his professional judgement and experience. These are the general procedures:

  1. Summarizing and review the various debt covenants from the clients and then test the completeness testing of the debt covenants
  2. Perform the positive confirmation on the selected sample size to confirm the existence of debts and their accuracy.
  3. Reviewing all the terms and conditions of debt and check the level of compliance
  4. Process of preparation and maintenance of amortization schedules.
  5. Obtain the schedule of debt or borrowing including the interest calculation at the end of the period or year-end. Ensure that the listing have certain important information including the name of the lender, maturity date, borrowing date, interest rate, interest date, and balance at the end of the reporting date
  6. Obtaining the board minutes with respect to new debts or borrowings

Audit Procedure for Provision

What is an audit procedure?

Audit procedures also referred to as audit programs involve the procedures, methods, and strategies that auditors implement in order to achieve audit confirmation. It assists them to deduce if the audit objective was fulfilled according to the given data. 

Auditing is carried out in three steps:

Step 1 – Recognize the statement claim being tested

Audit procedures are carried out in order to test financial statement claims. Hence, the initial step in the auditing procedure is to recognize the statement claim that would be tested.

Step 2: Planning the audit procedure

Planning the audit procedure before performed helps avoid any risks.

Step 3: Important aspects to consider while finalizing the audit procedure

  • Be Clear – Every step performed should be clear so that a junior auditor can also benefit and be able to comprehend the audit process.
  • Provide Reasoning – Along with the procedure, there should be solid reasoning of the chosen audit procedure. It assures the that the entity has gained goods from an approved purchase order.
  • Practice audit terminology – The terms associated in the audit language can be used like ‘trace’, ‘cast’, ‘agree’, etc.

What is provision?

A provision is a control against profit and it is not an assumption of profit. It is debited to profit and loss. In order to meet a liability, provision is made. It’s known but the amount of it cannot be precisely calculated. One of the best examples of this can be provided for depreciation.

To calculate the real profit and loss, it is required to make provisions. All the provisions are debited to the profit and loss account regardless of the amount of profit or loss. If the amount or the payment timing is undefined then the provisions come under the form of payable, which is harder to audit. In such cases, the auditor needs to:

  • Verify with a discussion with the client whether the obligation truly occurs giving rise to the provision. 
  • Attain approval of the clients’ lawyers to reach the possible consequence and chances of doing payment eventually.
  • Examine following procedures so the issues settle while the audit is taking place.
  • Get a letter of representation from the client, as the matter is centered around decision and doubt
  • Recalculate the provision if possible, e.g. assurance of repairs provisions.

Examples of provisions include:

  • Provision for corrupt and uncertain debts
  • Provision for income tax
  • Provision for conditional liability
  • Provision for unpaid liabilities, etc.

Audit procedure for provision

Auditors should get adequate audit data to determine whether an accounting estimation is valid and that release is suitable. In order to fulfil the task they should follow these steps:

  1. Assess and evaluate the procedure taken by management to progress the estimation
  2. Check the agreements or guidelines for the terms of the contract to achieve a satisfactory responsibility
  3. Analyze messages with clients during the time period to achieve an understanding of the statements previously evolved during the year
  4. Execute reasoned trials to associate the level of contract provision year on year, and equate the budgeted to real provisions
  5. Re-evaluate the warranty provision
  6. Approve the percentage functional in the calculation to the indicated accounting plan of the client
  7. Appraise board minutes to discuss the current warranty assertions, and get the endorsement of the amount delivered

Responsibilities of the auditor during the audit procedure of provisions

It is the responsibility of an auditor to make sure that all the provisions are completed during the year with caution. The following is the significant part of auditors that they perform during verifying provisions:

  • Confirm that provisions are performed with respect to all obligations and contingencies.
  • Make sure that the sum provided is acceptable.
  • Inspect the minutes of the meeting of the panel of executives and the requirements of Articles of Association concerning the provisions to be prepared.
  • Certify that all provisions are performed in consideration to debiting the profit and loss account.
  • Certify that the provisions are consumed only for the aim of which they are produced.
  • Ensure that the financial statements have all the appropriate  provisions


A company reaches profit only after making essential provisions. If the provisions are insufficient, the profit may be exaggerated and thus surplus may be paid out of capital. On the other hand, if additional provisions are made, the account may not demonstrate the actual and reasonable condition of the dealings of the business.