Companies prepare financial statements to report their financial standing. These statements usually include the balance sheet and income statement. While these are the most prominent ones, companies also prepare the cash flow statement and statement of changes in equity. Usually, companies report financial information in their accounts at the end of each accounting period. This account may fall quarterly, annually, or monthly.
Stakeholders use these financial statements for various reasons. Usually, they rely on the information presented in those statements for decision-making. However, they may not show a true and fair view of the company’s standing. This issue has existed previously and has created problems for users of the financial statements. However, external audits have fixed most of the limitations of the financial statements.
An external audit is a process where independent auditors examine a company’s financial statements. Based on their examination, they conclude whether those statements are free from material misstatements. For this process, they rely on testing audit assertions. Several of these assertions exist, which auditors may check. However, it is crucial to understand what audit assertions are first.
What are Audit Assertions?
All companies prepare financial statements to present their financial standing. In some cases, they must report them to conform with rules and regulations. These rules may come from the government or a regulator. However, preparing those statements does not suffice. Companies ensure they do so accurately and transparently. During this process, companies use assertions to support the preparation process.
Audit assertions are claims made by management when preparing financial statements. These claims certify those statements are complete and accurate. Therefore, other names may include management or financial statement assertions. In some cases, these assertions may be explicit and stated directly. Other times, they may also be implicit and have an indirect impact. Either way, they are crucial in preparing financial statements.
An auditor’s primary job is to examine a company’s financial statements. As mentioned, they do so to conclude whether those statements are free from material misstatements. Similarly, they help auditors assess if financial statements present a true and fair view. Auditors use audit assertions as guides to help guide their audit process. Usually, they examine each assertion to ensure their conclusions are accurate.
Audit assertions differ based on the financial statement that auditors check. Moreso, they depend on the type of item under examination. For account balances, these assertions differ from transactions and events. Some audit assertions may also be similar for each type. Usually, these assertions impact the balance sheet and the income statement. However, it does not imply that audit assertions have a limited scope.
Overall, audit assertions represent claims made by management when preparing financial statements. These assertions are crucial in reporting financial information. For auditors, audit assertions are critical in examining financial statements. They use those assertions to guide their work and ensure they meet their objectives. While audit assertions apply to the balance sheet and income statement, they may have a wider scope.
What are the five audit assertions?
Auditors use numerous audit assertions when examining a company’s financial statements. However, they categorize those assertions into three types. The first relates to the balance sheet or account balances. On the other hand, the second relates to transactions and events. Those assertions relate to the income statements. Lastly, the last type concerns presentation and classification. Together, these assertions help in preparing financial statements.
Sometimes, however, auditors may not have enough time to examine all audit assertions. Therefore, they must focus on the most important ones. While classifying audit assertions based on importance is not possible, some of them may be more crucial. Auditors can use them as a reference to guide their work in examining financial statements. Overall, the five audit assertions considered critical are as follows.
Completeness applies to both account balances and transactions and events. This assertion relates to whether the amounts in the financial statement are complete. In other words, it helps ensure companies record transactions that were supposed to have been recognized. However, that definition applies to transactions and events. For account balances, it checks the completeness of asset, liability and equity balances.
Completeness is a crucial audit assertion since it relates to the balance sheet and income statement. Auditors can use it as a reference for many tests. For example, they must ensure companies have recognized all items in fixed assets that they must have. For that, auditors may use various tests and audit procedures to ascertain the completeness of those assets.
Accuracy is another audit assertion that concerns transactions and events. Hence, it impacts the income statement. It relates to ensuring transactions recorded in the accounts are at appropriate amounts. Through the income statement, accuracy can also affect the balance sheet. For auditors, it is crucial to ensure amounts recorded in the financial statements are accurate. This way, auditors can ascertain the financial statements are free from material misstatements.
Accuracy may not concern the balance sheet. However, auditors can use the valuation assertion to test account balances. In that context, it relates to the amounts recorded for assets, liabilities and equity. Auditors must ensure those accounts have received proper valuations from the management. Therefore, it can result inaccurate figures in the financial statements.
Occurrence is an audit assertion that relates to transactions and events. This assertion requires auditors to ensure the transactions recorded in the income statement have actually occurred. This way, they can separate whether any unsupported or fictitious transactions. For example, auditors can examine an expense by checking the supporting documents. They can also use other methods to check for occurrence.
Existence is similar to the occurrence. However, it concerns account balance rather than transactions and events. This assertion checks if asset, liability or equity balances in the balance sheet actually exists. More specifically, it ensures these balances represent actual items. Auditors can use various procedures to check this assertion. For example, inventory counts are a part of checking existence.
The classification assertion concerns two areas of an audit. The first relates to the income statement or transactions and events. There, it relates to whether companies have classified and presented transactions fairly. This assertion may relate to the allocation of expenses between various headings in the income statement. For example, companies may allocate depreciation to different business areas.
Classification also concerns the presentation and disclosures. It ensures companies have disclosed events, transactions, balances, and other matters with proper classification. Similarly, it relates to the clear presentation that promotes the understandability of information. With this assertion, auditors can check for various disclosures and their proper classification. For example, related party transactions may be a part of it.
Rights and obligation
Rights and obligations relate to accounting balances in the balance sheet and include two parts. The first is the rights associated with assets. In that context, it ensures companies include assets in their account of which they have a right of ownership or usage. This assertion concerns the definition of “assets” in the contextual framework. Companies must only recognize assets if they own or control them.
The second part of this assertion relates to obligations. However, it doesn’t cover assets. Instead, it focuses on the liabilities disclosed in the balance sheet. In this context, auditors must ensure that companies recognize liabilities if they have an obligation. This assertion concerns the definition of “liabilities” in the contextual framework.
Audit assertions are claims made by management when preparing financial statements. In an audit, it is crucial to ascertain these assertions. Auditors can use these assertions to guide their audit work. There are three categories of audit assertions. While one does not prevail over another, auditors can still focus on some more. Of these, the five audit assertions of significant importance are available above.