Despite any reliance on any controls, the auditor must substantiate the substance of the accounts. He must obtain evidence that the accounts give a true and fair view. To do that he has to verify the amounts attached to assets and liabilities in the accounts.
Verification is defined as proving the authenticity of the recorded amounts of assets and liabilities. Verification is achieved by confirming certain factors about an asset or a liability balance.
Whilst you study this lesson you should have in mind at all time the objective of the auditor and the purpose of the evidence being sought. ISA 500 Audit Evidence was introduced in lesson 4 in which we established the financial statement assertions of:
- Right and obligations
- Presentation and disclosure.
The auditor needs to substantiate these assertions with substantive procedures.
You should keep in mind the audit testing techniques (Analytical procedures, Enquiry, Inspection, Observation, and Computation). Remember that audit evidence should be sufficient and appropriate.
You will also need to have a thorough knowledge of the accounting standard requirement from your financial accounting studies (for example, financial accounting III and IV). Please also note that the detail of the accounting standard requirements IS NOT repeated in this textbook.
Armed with these ‘tools’ and common sense approach you should be able to design an audit programme to deal with all areas of the financial statement. You should bear in mind also that most of the following matters have a similar theme. They are likely to have some or all of the following conditions in common:
- Be a critical area of the financial statements
- The subject of an accounting standard which has specifics disclosure requirements and recognition and measurement principles.
- A contentious or subjective accounting area which has alternative treatments
- A high risk matter
- An area involving high degree of judgment
- An area where the main source of evidence is that from management.
The examiner is likely to ask questions on areas of the financial statements which require students to demonstrate that they can apply an effective audit strategy to them.
Verification has objectives very similar to the objectives of substantive tests that we covered under audit evidence and these are:
5.11 Cost: This represents the original monetary amount at which an asset was acquired or a liability was incurred. It is crucial to determine cost because for most assets under the historical cost accounting convention valuation is a function of cost.
5.12 Authorization: This is to ensure that there is proper authority to acquire the asset or incur the liability. Thus every transaction that results into an asset or a liability must be authorised at the appropriate level.
5.13 Valuation: Assets and liabilities should be disclosed at the appropriate carrying amount. Assets are usually valued at cost less a provision thus, fixed assets are valued at cost less depreciation. Stocks are valued at cost less provision for obsolescence, debtors are valued at cost less provision for bad and doubtful debts. Fixed assets can also be valued at a valuation less depreciation based on that valuation. Liabilities are normally valued at cost unless they involve interest for late payments or foreign exchange transactions.
5.14 Existence: Not only should assets and liabilities have a cost and a value there has to be evidence that they actually exist, because assets could have been lost, stolen or otherwise deteriorated.
5.15 Beneficial Ownership (Rights and Obligation)
This is exactly the same as rights and obligations under audit evidence. The assets may exist, they may have a value, the company may even have paid for them but does a company own them? So we want to ensure that assets and the rights of the entity and liabilities are obligations of the entity. We have to consider here also substance over form. Substance over form requires consideration of the financial and commercial reality of transactions and not merely their legal form.
Presentation in the accounts should be clear and unambiguous, appropriate to the nature of the business, in accordance with relevant accounting standards, in accordance with relevant legislation and consistent with previous years. Materiality must be considered in all these matters so that trivial matters are not given undue prominence in the classification, description and categorisation of accounts balances.
Examination papers will invariably contain a question on verification of assets and liabilities. Therefore the student must remember these seven important words mentioned above, because their knowledge can be applied to any question on verification and the student can achieve a good result.
- Beneficial ownership and