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Canada (161,930)
MGAD10H3 (23)
Kevin Ha (16)
Chapter 10

MGTD60 - Chapter 10

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Financial Accounting
Kevin Ha

MGTD60H3 – Chapter 10 – Substantive Testing and Balance Sheet Accounts Introduction: - Objectives of substantive testing - The factors that affect the nature, timing, and extent of procedures - Process that impact significant accounts in the BS - Illustrative procedures for auditing the significant accounts 10.1 – Relationship between Risk Assessment and Substantive Procedures - Substantive procedures are also called substantive testing or test of details - Substantive procedures are audit procedures designed to detect material misstatement at the assertion level Extent of Substantive Procedures - Extent of substantive procedures depends on the risk assessment for each significant accounts - Accounts that are clearly trivial and immaterial are ignored or only subjected to analytical procedures - Analytical Procedures are evaluations of financial information made by a study of plausible relationships among both financial and non-financial data o It encompasses the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts - Professional judgement is critical and it is influenced by factors such as materiality, the nature of the account balance or disclosure, and the risks identified - Risk assessment is determined using the audit risk formula (inherent risk, control risk, and detection risk) - If inherent and control risks are assessed as low, substantive testing is needed - If inherent and control risks are assessed as medium or moderation, a combination of tests of controls and substantive procedures are required Timing of Substantive Procedures - Timing depends on the risk assessment of the significant account or disclosure in question o Significant account is an account or group of accounts that could contain material misstatements based on their materiality and/or relationship to identified inherent and FS risks - The higher the detection risk for an account, the less work is needed to be performed, and a greater reliance on the tests of control before year end is placed - The lower the detection risk, the more work is needed to be performed, with the majority of evidence being obtained by performing substantive procedures near or at year end - Factors influencing timing of work performed: o Reviewing events occurring prior to year end  Major business acquisitions or disposals MGTD60H3 – Chapter 10 – Substantive Testing and Balance Sheet Accounts  Key charges to expense accounts (payroll bonuses)  Major fixed asset additions or disposals o Reviewing the activity in the period to date  Monthly review of the aging of TR o Performing general audit procedures prior to year end  Accumulation of knowledge throughout the year  Review of board minutes, journal entries, and legal correspondence  Performed at interim date with an update at year end o Reviewing provisions prior to year end  Familiarization with the approach taken by management prior to year end so the auditor can begin to develop an expectation of the balances in advance of the year end visit 10.2 – Substantive Testing of Cash - Presented as single line item on the BS - Consists of cash on hand, cash in the bank, and cash equivalents - Cash Equivalents are highly liquid investments that can be quickly converted into cash - Imprest Payroll Accounts are accounts established for processing payroll disbursements only - Cash balance presented as a liability is called Bank Indebtness which happens when a firm has access to a bank overdraft facility and has spent more cash on hand - 3 (and 1 extra) important assertions regarding cash: o Existence  Verified by the receipt of a confirmation from the bank  Bank should also confirm whether they are any additional accounts, loans, pledges, lease facilities, or other banking facilities o Completeness (balance completely reflects all cash transactions)  Testing bank reconciliation by vouching any differences between cash as per the bank statement and cash as per the general ledger to supporting documentary evidence  Fees and interests should be vouched to the general ledger as evidence that client has reconciled the items  Difference between vouching a bank statement and a general ledger is often the result of cheques that have been issued but have not yet cleared the bank o Classification  Additional information related to cash account that is required to be disclosed in the FS  Unused credit facilities and other information that is part of the cash flow statement disclosure requirements o Rights and Obligations  Clients might have pledged assets such as cash (cash restriction) o Valuation and Allocation is not as important but only in situations where clients have foreign exchange transactions MGTD60H3 – Chapter 10 – Substantive Testing and Balance Sheet Accounts Principal Objectives in Auditing Cash - Note that classification assertion is different from classification and understandability assertion - Classification and understandability assertion relates to the presentation and disclosure in the FS, while classification refers to transactions and events that occur throughout the year (how they are recorded and if they are recorded in the right account) 1. All cash on the BS is held by the entity or by others (bank) for the entity (E) 2. All cash owned by the entity at year end is included in the BS (C) 3. Cash is stated at its realizable value (VA) 4. Entity owns or has legal rights to all the cash on the BS at year end (RO) 5. Cash is properly classified, described, and disclosed in the FS including all notes and restrictions in accordance to IFRS/GAAP (CL and CU) Factors Impacting the Audit of Cash - Testing performed at an interim stage over cash receipts and disbursements - If controls are effective, no additional test of control is required to be performed - Thus, the auditor would perform substantive tests to audit cash at year end with no additional process or control related testing required - Most transactions flow through the cash account at some point and therefore cash is qualitatively material - Cash tends to have high inherent risk if an organization has a large number of cash transaction during the year - Cash is the easiest to steal - Analytics over the cash accounts are generally not used because cash is considered “lumpy” and unstable - Procedures can be performed as part of control test (dual) - Example of substantive tests of transactions – cash: CASH RECEIPTS PROCESS CASH PAYMENTS PROCESS Proof of cash by: Account for the numerical sequence of - Reconciling activity per client rectors to cheques issued during a specified period activity per bank - C, CO (Cut-off) - Correlate these transactions to the activity in the sales and TR ledgers - C, A Compare remittance advices or lists of cash - Compare paid cheques and documents receipts with entries in the cash receipts with the cash disbursement journal journal - Check if documents confirm it has been - CL, C paid - C - Compare the details of duplicate Compare entries in cash journal with paid deposit slips with entries in the cash cheques and supporting documents receipt journal - O (Occurrence) - Investigate abnormal delays in MGTD60H3 – Chapter 10 – Substantive Testing and Balance Sheet Accounts depositing cash receipts - C - Compare total amounts of daily Test the account classifications of cash deposits shown in the bank statement payments with totals in the cash receipt journal - CL - Investigate unusual delays - C - Agree invoice amounts to cash Test the math accuracy of the cash received for cash sales transactions disbursement journal - Agree cash collected to the recorded - VA cash balance and document - C - Test the recording miscellaneous Test the postings of the totals in the cash receipts in the TR journal disbursement journal to general ledger and - See if the amount is reasonable subsidiary ledgers - A - C Compare entries in the cash journal with the Test posting of individual cash payments from remittance advice, etc the cash disbursements journal - O - CL Test accounting classification of receipts Determine if signatures on paid cheques are - CL, VA authorized - A Test math accuracy - A Test authorization of credits, discounts, and allowances - O, E Illustrative Procedures for Auditing Cash - Testing performed at an interim stage - Tests performed to confirm cash held by others and in hand: o Foot the bank reconciliation to ensure math accuracy o Trace the balance to general ledger o Agree confirmed balance o Obtain cut off bank statement o Determine whether outstanding cheques have subsequently cleared and deposit in transit has been recorded by the bank o Verify the appropriateness of reconciling items - Other example of procedures: o Review cash accounts for unusual item o Review bank confirmations, minutes of meeting, and loan agreements o Recalculate foreign currency accounts o Prepare a schedule of cash transfer before and after year end o Count cash on hand Common Evidence Internally and Externally MGTD60H3 – Chapter 10 – Substantive Testing and Balance Sheet Accounts - Internally: o GL, reconciliations, and minutes of BOD, and other - Externally: o Bank statements, bank confirmations, cheques, deposit slips, and bank agreements 10.3 – Substantive Testing of Trade Receivables (TR) - Two audit assertions important when TR is significant: o Existence  Verified by sending confirmations to the client’s customers  Positive confirmation only provides evidence about the balance owing  PC does not provide assurance that customers will pay the balance owing  Best way to ensure that the balance is valued correctly is by the full receipt of the cash by the client at year end o Valuation and Allocation  Additional test is required called Subsequent Receipts  A sample of TR at year end is vouched to the subsequent receipts  Used when auditor did
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