Auditing Financial Statement Assertions:
Existence, Rights, and Obligations
Introduction
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
Financial statement assertions are representations by management
regarding a company's financial statements. There are five key assertions
that underlie financial reporting: existence, rights and obligations,
completeness, valuation and allocation, and presentation and disclosure
(Arens et al., 2014). This paper will focus on the assertions of existence,
rights and obligations in the context of auditing.
The existence assertion refers to whether an asset or liability of the reporting
entity legally exists at a given date. The rights and obligations assertion
refers to whether rights and obligations of the reporting entity exist at a
given date. As auditors, we are responsible for obtaining sufficient
appropriate audit evidence to determine if the financial statement balances
presented by management regarding existence and rights/obligations are
accurate and in accordance with Generally Accepted Accounting Principles
(GAAP).
During the planning phase of the audit, knowledge of these key assertions
helps auditors identify areas of potential risk and determine the nature,
timing and extent of substantive audit procedures that will be performed.
Some common examples of substantive procedures related to existence,
rights and obligations include physical inspection, third party confirmations,
analytical procedures and vouching transactions to supporting
documentation.
This paper will discuss the audit procedures related to existence, rights and
obligations in more depth by providing examples in specific audit areas such
as cash, accounts receivable, inventory, long-term investments, property,
plant and equipment, accounts payable and long-term debt. It will also
address audit risks unique to each financial statement area and methods to
address those risks through the appropriate types of substantive audit
procedures. The goal is to demonstrate the auditor's responsibility in
obtaining sufficient appropriate audit evidence regarding financial statement
assertions of existence and rights/obligations across key accounts.
Existence Assertion - Cash
The existence assertion for cash involves confirming that cash amounts
reported on the balance sheet physically exist and are under the control of
the company at the period end date. Cash usually has a higher inherent risk
due to its liquid nature. Auditors address the existence risk of cash through
substantive procedures including:
- Physical inspection of cash: Auditors will typically request to physically
inspect cash on hand at period end for all significant cash balances. This
provides direct evidence that cash exists and is owned by the company.
Timing of physical inspection is important to correspond with period end
date.
- Bank reconciliations: Auditors will obtain and inspect bank reconciliations
prepared by management for all cash accounts as of the period end date.
This helps identify any unrecorded cash receipts or disbursements.
Reconciliations are traced to underlying source documents and accounting
records for accuracy.
- Bank confirmations: For all bank accounts with significant balances,
auditors will send confirmation requests directly to the bank to validate
period end balances provided by management per bank records. This also
requests disclosure of any liens, encumbrances or account restrictions.
- Subsequent cash receipts: Details of cash receipts immediately after period
end are inspected for any deposits of pre-period end cash receipts that were
unrecorded by management.
- Analytical procedures: Unusual fluctuations noted in cash balances, activity
or account reconciliations are investigated further through additional
inquiries, recalculations or extended procedures as warranted based on risk
assessment.
Rigorous procedures are performed at year end due to higher inherent
existence risk for cash. Periodic unannounced cash counts are also
considered during the year to improve ability to detect potential
misappropriation. Overall, multi-pronged procedures offer evidence regarding
existence of cash balances.
Existence Assertion - Accounts Receivable
For accounts receivable, existence risk involves whether receivables reported
on the balance sheet actually represent valid claims against customers for
goods or services delivered. Receivables are considered high risk given
possibility of inaccurate aging, uncollectable accounts or evergreening.
Substantive procedures to address existence risk include:
- Confirmation of receivables: Positive confirmations are sent directly to third
party debtors requesting validity of amounts owed to the company as per
management records. This offers direct evidence for existence of reported
receivables.
- Inquiry and inspection of subsequent cash receipts: For a sample of
receivable balances, auditors will trace cash receipts immediately after
period end to validate existence of reported receivables.
- Aging analysis procedures: Management's aging of receivables is
recalculated on a test basis and unusual trends are investigated further. Long
outstanding receivables are examined for collectability concerns.
- Analytical procedures: Significant ratio changes or account fluctuations
compared to prior periods and budgets are investigated further through
additional procedures.
- Review of credit memos/write-offs: Post period-end credit memos or bad
debt write-offs are inspected for potential improper receivables existence.
- Confirmation of terms: Disputes regarding agreed upon billing or payment
terms with customers are investigated for potential errors in recorded
receivables.
Multi-faceted procedures together provide evidence that reported accounts
receivable amounts represent valid obligations of customers at the period
end date.
Rights and Obligations Assertion - Inventory
The rights and obligations assertion for inventory involves confirming the
company owns and has title to inventory amounts capitalized on the balance
sheet at period end. Key audit procedures to address this assertion are:
- Inventory counts: Physical inspection of inventory is performed either at
year end or interim dates to determine if quantities exist per management
records.
- Inspection of goods received/acceptance records: Documentation of
quantity and quality inspection upon receipt of goods is examined for valid
rights of ownership by the company.
- Analytical procedures: Fluctuations in inventory balances, turnover ratios,
obsolescence percentages are investigated for reasonableness.
- Observation of inventory pricing and compiling test counts: Auditor
directly participates in the physical count process and inspects pricing
policies application in inventory valuation.
- Review of consignment/bailment agreements: Third party inventory held
or stored for the company is confirmed through inspection of legal title
documents.
- Inquiry of production/purchasing executives: Discussions held regarding
supply issues, defective inventory returns, slow moving inventory strategies
and write-downs to validate no title restrictions exist.
Evaluating the collective evidence obtained through multi-pronged physical
and analytical procedures provides assurance for the company’s ownership
rights over existence of inventory amounts.
Rights and Obligations Assertion - Property, Plant and Equipment
For fixed assets, auditors are concerned that property, plant and equipment
reported on the balance sheet represents legal claims or title rights of the
company at the balance sheet date. Common procedures used include:
- Inspecting legal/title deeds documentation: Originals or copies of property
purchase/lease agreements are inspected to validate the company's
ownership rights.
- Reviewing fixed asset registrar: Details of all additions/retirements during
the year are traced to underlying supporting documentation like invoices,
payment vouchers etc.
- Physically verifying fixed asset existence at locations: Important fixed
assets or samples drawn from each location are verified on a surprise basis
for actual existence.
- Inspecting minutes of BOD and shareholder meetings: Approvals for major
repairs, renovations, asset disposals, donations are verified from meeting
minutes.
- Discussing with production/operations management: Understanding any
disputes over possession rights, idle assets, seized assets, assets under
finance lease are acquired.
- Analytical review of depreciation expense: Significant variances compared
to budget or prior periods are investigated further regarding asset
transactions.
Conclusion
In conclusion, this paper discussed key financial statement assertions of
existence and rights/obligations that must be audited to provide assurance
to stakeholders regarding accuracy of reported financial information. Specific
examples across major financial statement line items demonstrated
substantive audit procedures commonly employed to obtain sufficient audit
evidence regarding existence of assets/liabilities and rights or obligations of
the reporting company. A risk-based audit approach is necessary in planning
and executing appropriate multi-faceted procedures tailored to each account
and risk factors present. Proficient application of such audit assertions
testing helps fulfill the auditor's responsibility to validate information
reported by management.
Rights and Obligations Assertion - Accounts Payable
For accounts payable, the rights and obligations assertion relates to whether
amounts recorded represent valid legal obligations of the company at period
end. Common substantive audit procedures in this area include:
- Creditor balance confirmations: Requests sent directly to major
vendors/creditors seeking validation of balances and disclosure of settlement
discounts or disputes as per company records.
- Subsequent payments testing: Tracing a sample of cash/cheque payments
immediately after period end to corresponding recorded payables to validate
obligations.
- Vouching transactions to receiving records: On a test basis, agreeing
recorded payables to purchase invoices, receipts and payment terms for
authenticity of valid debts.
- Analytical procedures: Investigating significant fluctuations in total
payables, average payment periods compared to budgets or prior periods.
- Review of credit memos: Inspecting credit notes received from suppliers
after period end for potentially unrecorded liabilities.
- Inquiry with purchasing department: Discussing disputes over invoices,
consignment inventory receipts, vendor payment disputes and known
unrecorded liabilities.
Combining positive confirmation from creditors, cross-checking to source
documents and analytical procedures substantiates recorded accounts
payable amounts represent actual liabilities of the company.
Rights and Obligations Assertion - Long Term Debt
Regarding long term debt obligations, the key focus is validating amounts
recorded on the balance sheet represent valid legal claims by
lenders/creditors over the company. Common audit procedures include:
- Obtaining debt agreement copies: Inspecting signed loan documents,
debenture trust deeds, finance lease contracts to verify debt covenant terms.
- Sending lender/trustee confirmations: Requesting direct confirmation of
outstanding principal and interest balances including mortgages, debentures
and finance leases.
- Recalculating interest computations: On a test basis, recomputing recorded
interest expense and balance sheet accruals based on agreement terms.
- Reviewing debt raising/repayment entries: Tracing additions/payments to
bank statements for authorized approvals and accurate recording.
- Examining debt covenant compliance evidence: Validating documents such
as net worth to debt ratios, loan-to-value certificates from lenders where
applicable.
- Scanning for unrecorded liabilities: Checking for new liabilities through
accounts payable searches, review of minutes and subsequent events
assessment.
Cross-validating recorded amounts, reperforming computations and scanning
for unrecorded items provides assurance over validity of long term
obligations.
Rights and Obligations Assertion - Issued Shares and Investments
For issued shares and investments, the rights and obligations assertion
relates to confirming amounts reported represent valid ownership claims by
the company. Regarding:
Issued Shares:
- Inspecting capital raised authorization from shareholders/BoD meeting
minutes
- Agreeing share certificates issued to cash/consideration received per
accounting records
- Reconciling share registers with depository/transfer agent records
Investments:
- Inspecting investment purchase agreements/broker contract notes
- Obtaining third party confirmation of balances from investee companies
- Recalculating investment valuations based on quoted prices
- Agreeing dividend/interest receipts to investee financial statements
- Reviewing investment disposals/write-offs to documentation
Scrutinizing legal purchase documents for investments, reconciling share
registers, recalculating valuations and cross-checking to third party records
validates reporting of issued shares and investments on a rights and
obligations basis.
Overall Assessment
In summary, audit procedures regarding financial statement assertions are
aimed at providing independent assurance to stakeholders on credibility of
information presented by management. For existence assertion, focus is on
confirming reported assets and liabilities legally exist at the balance sheet
date. Whereas for rights and obligations assertion, validating the company
has valid ownership or creditor claims over reported amounts.
As discussed through numerous practical examples, a combination of
positive confirmations, inspection of relevant documentation, analytical
procedures and cross-checking to source records enables auditors to
systematically obtain sufficient audit evidence supporting financial
statement assertions tested. Applying a risk-based approach tailored by
account ensures proper evaluation of inherent risks and fraud vulnerabilities
present. This fulfills auditors' responsibility of reasonably assessing that
information provided by clients meet GAAP requirements through
comprehensive assertion testing during the audit process.
