What are Management Assertions?
Management assertions are claims made by members of management regarding certain aspects of a business. The concept is primarily used in regard to the audit of a company's financial statements, where the auditors rely upon a variety of assertions regarding the business. The auditors test the validity of these assertions by conducting a number of audit tests. Management assertions fall into the following three classifications.
Transaction-Level Assertions
The following five items are classified as assertions related to transactions, mostly in regard to the income statement:
Accuracy. The assertion is that the full amounts of all transactions were recorded, without error.
Classification. The assertion is that all transactions have been recorded within the correct accounts in the general ledger.
Completeness. The assertion is that all business events to which the company was subjected were recorded.
Cutoff. The assertion is that all transactions were recorded within the correct reporting period.
Occurrence. The assertion is that recorded business transactions actually took place.
Account Balance Assertions
The following four items are classified as assertions related to the ending balances in accounts, and so relate primarily to the balance sheet:
Completeness. The assertion is that all reported asset, liability, and equity balances have been fully reported.
Existence. The assertion is that all account balances exist for assets, liabilities, and equity.
Rights and obligations. The assertion is that the entity has the rights to the assets it owns and is obligated under its reported liabilities.
Valuation. The assertion is that all asset, liability, and equity balances have been recorded at their proper valuations.
Presentation and Disclosure Assertions
The following five items are classified as assertions related to the presentation of information within the financial statements, as well as the accompanying disclosures:
Accuracy. The assertion is that all information disclosed is in the correct amounts, and which reflect their proper values.
Completeness. The assertion is that all transactions that should be disclosed have been disclosed.
Occurrence. The assertion is that disclosed transactions have indeed occurred.
Rights and obligations. The assertion is that disclosed rights and obligations actually relate to the reporting entity.
Understandability. The assertion is that the information included in the financial statements has been appropriately presented and is clearly understandable.
There is a fair amount of duplication in the types of assertions across the three categories; however, each assertion type is intended for a different aspect of the financial statements, with the first set related to the income statement, the second set to the balance sheet, and the third set to the accompanying disclosures.
If the auditor is unable to obtain a letter containing management assertions from the senior management of a client, the auditor is unlikely to proceed with audit activities. One reason for not proceeding with an audit is that the inability to obtain a management assertions letter could be an indicator that management has engaged in fraud in producing the financial statements.
Chapter 13 Audit of Non-Current Assets
LEARNING OBKECTIVES
1. Understand the audit objectives of auditing fixed assets.
2. Recognise internal controls applicable to the acquisition and disposal of fixed assets.
3. Design analytical procedures used in the audit of fixed assets.
4. Design and perform test of account balances for fixed assets.
1. Assertions for the Audit of Fixed Assets
1.1 The assertions for auditing fixed assets are as follows:
[Jun 11, Jun
13]
Assertions | Descriptions |
1. Existence |
|
2. Rights and obligations |
|
3. Completeness |
|
4. Accuracy |
|
5. Valuation and allocation |
|
6. Cut-off |
|
7. Classification |
|
8. Presentation and disclosure |
|
2. Inherent Risks for Fixed Assets
[Jun 11]
2.1 Inherent risks for non-current assets
[a] Difficulties in estimating the useful lives of the fixed assets.
[b] Revaluation of properties has been taken place with consequent subjectivity in
valuation.
[c] Fixed assets in the course of construction may have uncertainty about stage of completion.
[d] The company has capitalized some of its own costs of construction of fixed assets.
[e] The application of capitalization policies for repair and maintenance requires clear policies and
procedures for this and also subjective judgements.
[f] The existence of moveable, high value assets with high risk of loss.
[g] Technological changes affecting the industry, rendering the asset obsolete.
[h] The company owns a significant number of idle fixed assets
with uncertainty as to future use.
[i] Inadequate authorization for disposal and written off of fixed assets.
Question 1
The firm of VC & Co. in which you are employed is the external auditor of Company A which is a company that operates a training centre providing IT engineers courses & photography courses. The company leased a flat in a commercial building located in
Mongkok under an operating lease. The training centre promotes their IT engineers courses by providing powerful notebooks for students to use in class. At the same time, photographic equipment is provided to students to use when attending the classes of the photography courses. Recently, fewer and fewer students enroll on the photography courses, the directors consider not to offer those courses in the coming future. The company adopts the revaluation model for all the equipment.
Required:
[a] State and explain the assertions for the auditing of the account balances, additions and disposals of notebooks and photographic equipment. [8 marks]
[b] What is inherent
risk?
[2 marks]
[c] What are the inherent risks for the auditing of the notebooks and photographic equipment in this audit?
[4 marks]
[d] What are the relevant assertions affected by these inherent risks? Explain. [6 marks]
[HKIAAT PBE Paper III Auditing and Information System June 2011 Q2]
3. Internal Control for Fixed Assets
3.1 The internal controls for the acquisition of non-current assets are similar to those applied in purchase cycle.
Internal Controls | Internal Control Procedures |
[a] Approval of acquisition of fixed assets |
|
[b] Safeguard of fixed assets |
|
[c] Disposal of fixed assets |
|
[d] Maintenance, insurance and other charges associated with fixed assets |
|
[e] Authorization of depreciation charges and periodic review of accumulated depreciation |
|
4. Tests of Details of Balances – Fixed Assets
4.1 Steps for designing tests of details of balances
4.1.1 The steps are as follows:
[a] Assess client’s business risk, tolerable misstatements and inherent risks for fixed asset accounts.
[b]
Assess control risks for fixed asset accounts.
[c] Design and perform test of controls and substantive tests of transactions for the purchase and payment cycle.
[d] Design and perform analytical procedures for the purchase and payment cycle.
[e] Design tests of details of account
balances to satisfy balance-related audit objectives.
4.2 Analytical procedures
4.2.1 The nature of analytical procedures depends on the nature of client’s operations.
Analytical Procedures | Specific Purpose |
[a] Compare prior year’s balances and depreciation expense with current year’s balance, taking into considerations of any changes in conditions or asset composition | To identify any possible misstatement of depreciation expense, accumulated depreciation and net book value. |
[b] Compute the ratio of depreciation expense to the related PPE and compare to prior years’ ratios, taking into account of the company’s depreciation policy | To identify if there is changes in the rate of depreciation or error in the calculation of depreciation. |
[c] Compute the ratio of repairs and maintenance expense to the related PPE accounts and compare to prior years’ ratios. | To identify if expensing amounts that should be capitalized. |
[d] Relate the amount of insurance expense to the related PPE and compare to prior years’ amounts, taking into account of inflation adjustment. | To identify if the PPE have been under-insured that may lead to possible of substantial loss in events of accidence. |
[e] Review capital budgets and compare the amounts spent with amounts budgeted. | To identify any possible fraud or deviation from company’s policy and internal controls. |
4.3 Verification of carrying value of fixed assets
4.3.1 The following substantive procedures, for example, may be applied:
Items | Substantive Procedures |
[a] Current year acquisition |
|
[b] Current year disposal |
|
[c] Asset balance |
|
[d] Depreciation |
|
4.3.2 | Substantive procedures for the gain or loss on disposal of fixed assets [Dec 12, Dec 13] |
[a] Obtain the disposal of fixed asset schedule from the client. |
4.4 Tests of details of account balance to satisfy balance-related audit objectives
[Jun 10, Dec 11, Jun 13, Dec 13, Jun 15]
Audit Objectives | Substantive procedures |
1. Existence |
|
2. Completeness |
|
3. Accuracy |
|
4. Valuation |
|
5. Rights and obligations / ownership |
|
6. Cut-off |
|
7. Classification |
|
8. Presentation and disclosure |
|
5. Audit of Investment Properties
5.1 Inherent risk for investment properties [Dec 10, Dec 14]
5.1.1
The inherent risk of material misstatement of the existence of investment property should be low to medium.
5.1.2 The reasons are as follows:
[a] There is no indication of fraud.
[b] Investment property is not subject to misappropriation.
[c] Physical movements are usually
rare.
5.2 Internal control for investment properties
5.2.1 There should not be any difference in internal controls for the purchase and sale of investment properties process from those of PPE transactions [refer to point 3 above].
5.3 Tests of details of account balance – investment properties
5.3.1 The audit
procedures to verify the balance of investment property can be referred to those discussed in point 4 above.
5.3.2 The objective of accuracy in depreciation calculation is achieved by re-computation and reference to the entity’s depreciation policy. However, no depreciation is required if the entity adopts fair value model; therefore, the auditor has to ensure that a gain or loss arising from a
change in the fair value shall be recognized in profit or loss for the period in which it arises.
5.3.3 | Substantive procedures for the additions of investment properties [Dec 12] |
[a] Obtain the list of investment properties purchased. |
Question 2
HY Limited owns several [less than 10] expensive residential properties in Hong Kong and Mainland China, all are used for earning rental income. This is the major operating activity of HY Limited. The company is owned by six shareholders who engage two directors to operate the business. The director plan to acquire more and more properties in the future, therefore, a lot of resources are allocated to set up a good internal control system
for the collection of rental income.
Required:
[a] Assess with reasons the inherent risk of material misstatement of the existence of HY Limited’s investment properties.
[2 marks]
[b] Assuming that the substantive approach is adopted, list four audit procedures that should be performed in addressing the existence assertion of investment properties.
[4 marks]
[c] The company adopts the Fair Value Model for the accounting of the investment properties. The auditor has decided to use an expert’s services regarding the fair value of the investment properties.
What matters should be agreed between
the auditor and the auditor’s expert?
[6 marks]
[d] Assuming the substantive approach is adopted, what the audit procedures to be performed for the rental income?
[6 marks]
[e] Assuming the company maintained good internal control for the collection of rental income, is it appropriate for the auditor to adopt the substantive approach for the audit of rental income.
[2 marks]
[HKIAAT PBE Paper III Auditing and Information System December 2010 Q4]
6. Audit of Intangible Assets
6.1 Inherent risk for intangible assets
6.1.1 Intangible
assets that usually can be found in the financial statements of companies in HK are mainly purchased goodwill, patents, brand names, trademarks, copyrights, mastheads and research and development [R&D] expenditure.
6.1.2 The valuation of intangible assets involves the estimates of useful life and impairment losses. These kinds of estimates involve considerable judgement and may lead to disagreement
between the auditor and the client. In such a situation, the auditor may assess the inherent risk as high, especially, if the amounts capitalized are material.
6.2 Assertions for the audit of intangible assets
6.2.1 There should not be any difference in assertions for the audit of fixed assets [refer to point 1 above].
6.3 Tests of details of account balance – patent and trade marks
Audit Objectives | Substantive procedures |
1. Existence and rights of ownership |
|
2. Valuation [realizable value] |
|
3. Presentation and disclosure |
|
6.4 Tests of details of account balance – R&D
Audit Objectives | Substantive procedures |
1. Existence and rights of ownership |
|
2. Valuation [realizable value] |
|
3. Presentation and disclosure |
|
6.5 Tests of details of account balance – Purchased goodwill
[Jun 14]
Audit Objectives | Substantive procedures |
1. Existence and rights of ownership |
|
2. Valuation [realizable value] |
|
3. Presentation and disclosure |
|
Source: //hkiaatevening.yolasite.com/resources/PBEAuditNotes/Ch23-NonCurrentAssets.doc
If you are the author of the text above and you not agree to share your knowledge for teaching, research, scholarship [for fair use as indicated in the United States copyrigh low] please send us an e-mail and we will remove your text quickly. Fair use is a limitation and exception to the exclusive right granted by copyright law to the author of a creative work. In United States copyright law, fair use is a doctrine that permits limited use of copyrighted material without acquiring permission from the rights holders. Examples of fair use include commentary, search engines, criticism, news reporting, research, teaching, library archiving and scholarship. It provides for the legal, unlicensed citation or incorporation of copyrighted material in another author's work under a four-factor balancing test. [source: //en.wikipedia.org/wiki/Fair_use]
The information of medicine and health contained in the site are of a general nature and purpose which is purely informative and for this reason may not replace in any case, the council of a doctor or a qualified entity legally to the profession.
The texts are the property of their respective authors and we thank them for giving us the opportunity to share for free to students, teachers and users of the Web their texts will used only for illustrative educational and scientific purposes only.