VERIFICATION OF CURRENT ASSETS AND LIABILITIES

Verification of Current Assets

Inventory

Audit objectives

The audit objectives applicable to inventories are:
(a) Completeness
This is to ensure that:
(i) Inventories represent all raw materials, work-in-progress, and
finished goods that the entity owns, including those on hand, in
transit or on the premises of others.
(ii) All shipments of goods during the period covered by the financial
statements.
(b) Accuracy
This is to ensure that:
(i) The detailed perpetual inventory records are correct and agree
with the general ledger inventory control account.
(ii) Costs associated with inventories have been properly classified
and accumulated.
(iii) Cost of sales is based on correct costs and quantities, is properly
summarised and posted to the costs of sales and inventory control
accounts, and, where appropriate, is credited in the perpetual
inventory records.
(c) Existence/Occurrence
This is to ensure that:
(i) Recorded inventories physically exist in saleable condition and
represent property held for sale in the ordinary course of business.
(ii) Recorded cost of sales relate specifically to goods actually shipped
during the period covered by the financial statements.
(d) Cut-off
This is a procedure to ensure that production costs incurred are charged
to work-in-progress and on completion are transferred to finished goods
such that cost of goods sold are recorded in the period when the sales
are made.
(e) Valuation
This is to ensure that:
(i) Costs associated with inventories and costs of sales are
determined and accumulated using generally accepted
accounting principles consistently applied.
(ii) Inventories are stated at cost or net realisable value, whichever
is lower.
(f) Rights and obligation
This is to confirm that:
The entity has legal title or ownership rights to the inventory; inventory
excludes goods that are the property of others or have been billed to
customers.
(g) Presentation and Disclosure
This is to ensure that:
(i) Inventories and cost of sales are properly described and classified
in the financial statements.
(ii) All encumbrances against inventory are adequately disclosed.
The auditor achieves these objectives by performing substantive tests or a
combination of substantive tests and tests of control, structure, policies and
procedures.

Planning the Inventory Observation

The client has the primary responsibility for planning and taking the physical
inventory. The auditor should observe stocktaking and should include
observation of stocktaking in his planning of the audit. The client and auditor
should agree on the timing of the inventory after considering the following
factors:
(a) The inventory should be counted at year-end if it is subject to significant
volatility of movement or quantities, or if the control procedures for
accounting for movement are ineffective;
(b) If those procedures are effective, the count can be taken before year-end
or, if the client used cycle counts, on a staggered basis throughout the
year; and
(c) If the inventory is taken at once, both client and auditor usually prefer a
month in the last quarter of the fiscal year.
Unless the client has effective control procedures that address proper cut-off,
the auditor should discourage the client from taking inventories of different
departments over a period of several days; this could result in double-counting
of inventory.
The auditor should review and comment on the written instructions of inventory
plans. Often the client personnel responsible for the inventory hold one or more
instructional meetings with those who are to supervise the stock-taking. The
auditor’s presence at the meetings usually facilitates the plans for observing
the inventory.
There may be a need for large number of audit staff to be present when a
complete physical inventory is taken at a time than if cycle counts or staggered
inventories are taken.
Audit staffing requirements must be determined based on the following
variables:
(a) Timing of inventories at various locations;
(b) Difficulty of observing them; and
(c) Number of counting teams the client provides.

Observing the Physical Inventory

The auditor must keep in mind the objectives of observing a physical inventory,
namely:
(a) To ascertain that the inventory exists;
(b) To observe that the count is accurate;
(c) To ensure the description of the inventory is accurate; and
(d) To ensure that its condition is properly recorded.
An auditor is neither a taker nor an expert appraiser of inventory quality,
quantities, or condition; nonetheless, an auditor should intelligently apply
common sense. Well-arranged inventory is more likely to be accurately counted
than poorly arranged inventory. Signs of age and neglect are often obvious, for
example, dust on cartons or rust and corrosion of containers, and they naturally
raise questions about the inventory’s usefulness. The condition of the inventory
is particularly important if the product must meet technical health
specifications. Before observing the inventory auditor should know enough
about the client’s business to be able to recognise, at least in broad terms:
The product under observation and the measures appropriate to determining
its quality and condition.
Thus, an auditor should spend some time examining the inventory being
counted. However, the client, and everyone else concerned, should recognise
that the auditor is not acting as an expert appraiser.
The auditor should spend most of the time observing the client’s procedures in
operation. The diligence of the counting teams should be noted as to:
(a) How carefully they count, weigh, and measure;
(b) How well they identify and describe the inventory; and
(c) What methods they use to make sure no items are omitted or duplicated.
The auditor should also observe:
(a) Whether supervisory personnel are present;
(b) How planned recounting procedures are executed;
(c) Whether cut-off procedures are performed;
(d) How inventory count documents are controlled;
(e) How individual areas or departments are controlled and “cleared”; and
(f) Whether instructions are followed.
The auditor should do some test counts in order to:
(a) Confirm the accuracy of the client’s counting;
(b) Record evidence to corroborate the existence of the inventory for later
tracing to the inventory summary sheet; and
(c) Perform random selection, independent counting and comparison with
quantities recorded by the clients, provide evidence that all items on
hand are accurately included in the client’s recorded counts.
The auditor should use judgement in determining how many test counts to
perform. In the absence of specific reasons to do otherwise:
(a) The auditor usually performs a small number of test counts in relation
to the total number of items in the inventory;
(b) Where there are an unacceptable number of errors in a particular location,
the client would ordinarily recount the inventory; and
(c) The auditor should record the test counts for subsequent tracing to the
inventory summarisation.
Client inventory counts are commonly recorded at least in duplicate, with one
copy retained at the scene of the count and another collected for summarisation.
The client normally controls the summarisation process, and the auditor makes
notations of tag or count sheet numbers or other control data on a test basis for
later tracing to the summarised records to provide corroborative evidence that
the process was adequately controlled.
As part of the review of plans and observation of the physical inventory
procedures, the auditor should note and evaluate the procedures followed in
separately identifying and counting items moved from one place to another
(such as from department to department) and goods on hand belonging to
others, such as consignments, bailment, goods on approval, and property of
customers returned for repair or held awaiting delivery instructions. All items
belonging to others should be counted and recorded separately, both because
they should be subject to control and to preclude their mistaken or purposeful
substitution for the client’s inventory.
In order to adequately identify work-in-progress, especially its stage of
completion, auditors should:
(a) Check the bill of materials or similar document; and
(b) Identify items in process and their condition or stage of completion.

Perpetual Inventories (Cycle Counts)

All procedures applicable to wall-to-wall physical inventory observation can
be readily adapted to cycle count observation. The auditor can:
(a) Review the cycle counting schedules, plans, and instructions; and
(b) Observe the physical arrangement and condition of the inventory.
The diligence and proficiency of the inventory count teams in counting,
identifying inventory, and controlling records of test counts, would prevent
omissions or duplications, and help in identifying and segregating slowmoving,
obsolete, or damaged goods. In a situation where the entire inventory
is not being counted at the same time, the auditor must take steps to ensure
that the items counted are properly identified. The auditor can make few test
counts either independently or with the count teams and can observe and, if
desired, participate in reconciling the counts to perpetual records and
investigating differences.
Effective cycle counting depends on:
(a) Effective control procedures for inventory quantities; and
(b) Timely recording throughout the production process.
Once the client’s procedures for controlling inventory quantities and related
cycle counting are found to be effective, the auditor can choose to observe and
test physical inventory procedures at any other time.
The auditor also needs evidence that the perpetual inventories procedures
observed:
(a) Were functioning before;
(b) Can be expected to function after they were observed; and
(c) That they are applied to substantially all inventory items.
A formal schedule of counts and specific assignments (covering both personnel
to perform the counts and supervisory responsibility) is preferable. Many
companies, however, operate under a loose policy of counting all items at least
once a year and assign the counting to the stock keepers to do as time allows.
In those instances, the auditor can review work sheets, entries in the perpetual
inventory records and other evidence of the regularity of test counting, and can
evaluate the results. Evidence of proper count procedures include:
(a) Frequent counting; Absence of substantial differences between counts
and records over a period of time;
(b) Quality of investigation of differences that occur and those investigating
differences;
(c) And quality of storeroom, housekeeping and inventory identification.

Difficult Inventories

Certain types of materials - for example, logs in a river, piles of coal and scrap
metal, chemicals - by their nature may be difficult to count, and an auditor
may have to use ingenuity to substantiate quantities on hand. Measurement of
a pile of metals, for example, may be difficult for a number of reasons:
(a) The pile may have sunk into the ground to an unknown depth;
(b) The metals may be of varying weights, precluding the use of an average;
and
(c) The pile may be of uneven density.
The quality of chemicals and similar materials may be impossible to determine
without specialised knowledge, and the auditor may find it necessary to draw
samples from various levels of holding tanks and send them for independent
analysis. Irregularities have been perpetrated by substituting water for
materials stored in tanks.

Alternative Procedures when Observation is Impracticable

The auditor should not readily take observation of inventories as impracticable
or impossible. In a situation where the client does not or cannot take a physical
inventory, or if the auditor cannot be present at the stocks taking, the auditor
may be able to form an opinion regarding the reasonableness of inventory
quantities by applying any of the following alternative procedures:

Examining Other Physical Evidence that may be Tantamount to Observing Physical Inventories

If the auditor is engaged after the physical inventory has been taken, subsequent
physical tests may be a satisfactory substitute for observing the inventorytaking.
The auditor may also examine written instructions for the inventorytaking,
review the original tags or sheets, and make other suitable tests. In any
event, the auditor must:
(a) Examine or observe some physical evidence of the existence of the
inventory; and
(b) Make appropriate tests of intervening transactions or control procedures
applied to them.
If the auditor is satisfied that inventories are fairly stated; he or she is in a
position to express an unqualified opinion. Otherwise, there may be no
practicable substitute for observation of inventory-taking, and an auditor may
have to express a qualified opinion or disclaimer, depending on the materiality
of the inventories and on whether failure to observe was unavoidable or resulted
from management’s decision to limit the scope of the audit.

Substantiating Through Further Examination of Accounting Documents

Sometimes procedures for substantiating inventories must be based on
examining other accounting documents and records. For example, in an initial
audit, the auditor generally would not have observed the physical inventory at
the previous year-end, which is a principal factor in determining cost of sales
for the current year. If reputable independent accountants expressed an
unqualified opinion on the prior-year statements, a successor auditor may
accept that opinion and perhaps merely review the predecessor auditor’s
working papers supporting the prior-year balances. If no audit was made for
the preceding year, the auditor may have no alternative but to substantially
expand the tests of accounting records to attempt to obtain reasonable assurance
about the beginning inventories in order to be able to express an opinion on
the current year’s results of operations.
Those expanded tests may include a detailed examination of physical inventory
sheets and summaries, including review and testing of cut-off data,
examination of perpetual inventory records and production records, and review
of individual product and overall gross profit percentages. In connection with
the latter procedures, cost accumulations for selected inventory items should
be tested and significant changes in unit costs directly traced to factors such as
technological changes, mass buying economies and changes in freight rates,
changes in labour costs, and changes in overhead rates.
Changes in gross profit percentages should be further related to changes in
unit sales prices and changes in the profitability of the sales mix, if applicable.
An auditor who is unable to form an opinion on the opening inventory may
decide to qualify the audit opinion or disclaim an opinion with respect to results
of operations for the year under audit.

Testing Ownership and Cut-off

The auditor must determine that the client holds title to the inventories. Where
materials are imported by the entity, the shipping documents determine the
ownership of the consignment. The test of ownership of such materials includes:
(a) Shipping documents showing consignee, Free on Board (FOB) terms
and bill of lading; and
(b) Actual receipts of the materials into the client’s warehouse.
In the case of the cut-off test, the auditor needs to ensure:
(a) The completeness of primary documents such as purchase and sales
invoices;
(b) The invoices so issued followed pre-numbered serials;
(c) Purchases are generally recorded when received; and
(d) Sales are made when the transactions took place.
Determination of ownership would depend on proper control of receiving and
shipping activities and cut-offs at year-end and, if different, at the physical
inventory date.
At the time of the inventory observation, the auditor should:
(a) Visit the receiving and shipping departments;
(b) Record the last receiving and shipping document numbers; and
(c) Ascertain that each department has been informed that no receipts after
or shipments before the cut-off date should be included in inventory.
After the inventory, the auditor should:
(a) Review the records of those departments; and
(b) Compare the last receiving and shipping numbers with accounting
department records to ensure that a proper cut-off was achieved.
Special care should be taken to control the movement of inventory when
manufacturing operations are not suspended during the physical inventory. If
there are consignment inventories, inventories in public warehouses, or
customer inventories, those procedures must be expanded. Inventory held by
others should be substantiated by direct confirmation in writing with the
custodians.
If such inventory is material, the auditor should apply one or more of the
following procedures to obtain reasonable assurance with respect to the
existence of the inventory:
(a) Test the owner’s procedures for investigating the stock-keeper and
evaluating the store keeper’s performance;
(b) Obtain an independent accountant’s report on the store-keeper’s control
procedures relevant to custody of goods and, if applicable, pledging of
receipts, or apply alternative procedures at the warehouse to gain
reasonable assurance that information received from the warehouseman
is reliable;
(c) Observe physical counts of the goods, if practicable and reasonable;
and
(d) If warehouse receipts have been pledged as collateral, confirm with
lenders pertinent details of the pledged receipts.
If goods are billed to customers and held for them, care must be exercised to
exclude the goods from inventory and to determine that the customers have
authorised billing before delivery. Goods belonging to customers or others
should be counted and, if significant in amount, should be confirmed with their
owners. The auditor should be alert to the possibility of such goods and should
ensure that the client properly segregates and identifies them.
The auditor should also be alert for liens and encumbrances against the
inventories. These are normally evident from reading minutes and agreements,
or as a result of confirmations with lenders relating to loans or loan agreements.
It may be necessary to investigate whether additional liens and encumbrances
have been filed with relevant authorities.

Valuation of Inventory

Generally accepted accounting principles require that inventories be reported
at the lower of historical cost or market (current replacement cost), provided
that the carrying value should not exceed net realisable value (estimated selling
price minus costs of completion and disposal) or be lower than net realisable
value reduced by the normal profit margin. To achieve the valuation objective
for inventories, the auditor should test the inventory costing. In addition, he
should:
(a) Review and test procedures for identifying obsolete or slow-moving
items;
(b) Review the costing of damaged or obsolete items to determine that the
assigned value does not exceed net realisable value; and
(c) Review and test the determination of market prices to determine whether
market value is lower than cost.
The auditor should:
(a) Consider not only finished goods but also work in process and raw
materials that will eventually become finished goods in the review for
obsolete items;
(b) Compare quantities with those in previous inventories on test basis to
identify slow-moving items or abnormally large or small balances; and
(c) Reviews of usage records can provide further indications of slow-moving
items.
If the client does not maintain perpetual records, the auditor may examine
purchase orders or production orders to determine how recently certain items
of inventory were acquired. Many companies have formulae or rules of thumb
that translated overall judgements on obsolete stocks into practical detailed
applications, for example:
(a) All items over a year’s supply;
(b) All items that have not moved within six months; and
(c) All items bearing certain identifying numbers with regard to date or
class of product.
The auditor should review whether the rules are realistic and comprehensive
enough as well as whether they are fully and accurately applied. In addition
to reviewing and testing the client’s rules, the auditor must evaluate, based on
an understanding of the client’s business climate, whether inventory can be
realised in the normal course of operations. Past experience can be a good
guide to the net realisable value of items that must be disposed of at salvage
prices.
When certain finished goods are declared obsolete or severe markdowns are
required, consideration should be given to related raw materials and work-inprocess
inventories write down.

Verification of Cash Sales

Cash sales are included under this topic because of the level of cash transactions
in Nigerian economy. In the supermarkets, restaurants, filling stations, etc,
transactions are made predominantly by cash. Physical and accounting controls
on cash pose problems. Segregation of duties between access to merchandise
and access to cash receipts is difficult, hence control procedures are put in
place to improve accountability. For effective control, customers are encouraged
to demand for receipts to cover cash payments.
Steps in verification of cash sales are:
(a) Obtain records of the entity’s daily cash sales;
(b) Check the records of cash receipts with the totals of the cash register;
(c) Investigate and obtain necessary explanations for any discrepancy;
(d) Check the procedures for cash transactions; and
(e) Conduct cash count.

Cash Balances

It is assumed that the auditor, using appropriate combination of risk assessment
activities and substantive tests, would have reduced audit risk to an
appropriately low level with regard to cash receipts from customers, cash
disbursements to vendors, and other cash transactions. Because cash is so liquid
and transferable, the risk of theft is greater than that of any other asset.
Accordingly, the auditor focuses on how responsive the client’s control structure
policies and procedures are to the inherent characteristic risk.
Failure to detect cash defalcations is frequently a source of embarrassment to
the auditor. It may be the basis for litigation; particularly if it involves material
fraud that a client contends should have been detected by an auditor following
a testing plan that gave appropriate consideration to the inherent risk associated
with cash and the client’s response to that risk. Cash defalcations are concealed
by unauthorised charges to income statement accounts, resulting in income
statement containing misclassified or fictitious expenses.
The nature, timing and extent of substantive tests of cash are strongly influenced
by the auditor’s assessment of inherent and control risk. The effectiveness of
control procedures also affects the timing of substantive tests.

Audit Objectives

The objectives of auditing cash are to obtain reasonable assurance that:
(a) Recorded cash on hand and in financial institutions, exists, and is
accurate and complete, and the client has legal title to it at the balance
sheet date;
(b) All items properly included as part of cash are realisable in the amounts
stated; for example, foreign currency on hand or on deposit in foreign
countries is properly valued;
(c) Cash restricted as to availability or use is properly identified and
disclosed; and
(d) Cash receipts, disbursements, and transfers between bank accounts are
recorded in the proper period.
Cut-off objective with respect to cash receipts from customers and disbursements
to vendors should be met to prevent end-of-period “window dressing” of
working capital accounts. Recording bank transfers in the wrong period could
be a tell-tale of a defalcation.

Substantive Tests of Cash Balances

Substantive tests are as follows:
(a) Testing completeness, accuracy, and existence of year-end balances so
as to:
(i) Confirm balances and other information with banks and other
financial institutions;
(ii) Prepare, review bank reconciliations; and
(iii) Cash count.
(b) Testing bank transfer cut-off.
(c) Review restrictions on cash balances and related disclosures.

Confirmation of Bank Balances

The auditor should ordinarily confirm balances at year-end by direct
correspondence with all banks the client has conducted business with during
the year, regardless of whether all year-end reconciliation’s are reviewed or
tested. Usual practice is to confirm all bank accounts open at any time during
the year under audit. The auditor should ask the client to request the financial
institution to communicate directly with the auditor.

Indebtedness and Other Arrangements

A bank may have arrangements with or provide services to the client other
than maintaining deposits or granting loans.
Auditor should confirm:
(a) Amount(s) on deposit kept as a condition for a loan;
(b) Items held as agent or trustee, securities or other items in safekeeping
or for collection for the account of the client; and
(c) Other arrangements - such as oral and written guarantees, commitments
to buy foreign currencies, repurchase or reverse repurchased
agreements, and letters of credit and lines of credit.

Bank Reconciliation Procedures

Periodic reconciliation of cash receipts and disbursements to the amounts shown
on bank statements is key control procedure to meet the asset protection
objective for cash. The reconciliation procedure will be more effective if in
addition to reconciling the balances, the detailed items listed on the bank
statements are reconciled to the detailed items recorded in the accounts during
the period covered by the bank statement. Reconciling detailed items listed on
the bank statements ensures that all items recorded in the accounts, including
offsetting items within receipts or disbursements, are also recorded on the bank
statement and vice versa.
Effective segregation of duties requires that the person reconciling bank balance
to account balances does not have functions relating to:
(a) Cash receipts;
(b) Cash disbursements; and
(c) Preparing or approving vouchers for payment.
It also requires that the person performing the reconciliation obtains the bank
statements directly from the bank and makes specific comparisons, like
comparing paid cheques and other debits and credits listed on the bank
statement with entries in the accounts, examining cheques for signatures and
endorsements, and reconciling bank transfers.
The client’s reconciliation of bank accounts and the appropriate division of
duties with respect to cash balances and transactions are important control
procedures. The auditor’s assessment of how effective the client’s reconciliations
are determined by the nature, timing, and extent of many of the substantive
tests of cash. Other factors are:
(a) Adequacy of the accounting system;
(b) Competence of employees doing the reconciliations; and
(c) Segregation of duties.
The more effective the auditor finds the client’s reconciliations to be, that is,
the lower the assessed level of control risk, the less detailed the auditor’s
reconciliation procedures have to be.
Those procedures may range from simply reviewing the client’s reconciliations
at year-end, if control risk has been assessed as low, to performing independent
reconciliations covering the entire year using the proof of cash form. Generally,
performing proof of cash reconciliations for the entire year is considered
necessary only in special situations, such as when a defalcation is believed to
have occurred. Between those two extremes falls the auditor’s judgemental
discretion.

Review and Test of Client’s Reconciliations

If the auditor has assessed control risk as low, then merely reviewing the client’s
reconciliations at year-end may be appropriate. The steps in reviewing a client’s
bank reconciliation are:
(a) Obtain copies of the client’s bank reconciliations and establish their
mathematical accuracy;
(b) Reconcile the total of the bank balances on the reconciliations to the
general ledger balance. This will generally require using a summary of
the individual cash account balances in the general ledger account;
(c) Scan the bank reconciliation for significant unusual reconciling items
and adjustments, and obtain evidence to support them by inquiry or
examination of appropriate documents.
In addition to the review procedures the auditor may decide to test the client’s
reconciliations. The tests may be performed at an interim date, if the auditor
has assessed that the client’s reconciliations are subject to effective supervisory
control procedures. If supervision during the intervening period is not
considered effective, the auditor would probably perform the tests at year-end.
The following procedures in addition to steps (a) and (b) above are typically
performed in testing the client’s reconciliations:
(a) Determine that paid cheques, deposits, and debit and credit advices
appearing on the cut-off bank statements and issued on or before the
balance sheet date appear on the year-end reconciliations;
(b) Trace to the cash disbursements records outstanding cheques listed on
bank reconciliations but not returned with the cut-off statements;
(c) Trace deposits in transit on the bank reconciliations to the cut-off bank
statements and the cash receipts records, and determine whether there
are any unusual delays between the date received per the books and
the date deposited per the bank statements;
(d) Trace other reconciling items to supporting documentation and entries
in the cash records;
(e) Investigate old or unusual reconciling items. If cheques remain uncashed
after a specified period of time, the reason should be determined and
the amounts restored to the cash account; and
(f) Determine the exact nature of items on the year-end bank statements
not accounted for by the reconciliation procedures, such as debits or
credits followed by offsetting entries of identical amounts that appear
to be, or are represented by the client to be, bank errors and corrections
not so coded. If information in the client’s records is inadequate,
clarification should be requested from the bank. In these circumstances,
the auditor should consider performing a “proof of cash” reconciliation
(described below) if the client’s reconciliation process does not include
one. These procedures assume that the testing is performed as of the
balance sheet date and that cut-off statements for a reasonable period
after the balance sheet date are obtained from the bank.

Bank Transfer Schedule

To ensure there has been a proper cut-off at year-end, the auditor should
determine whether significant transfers of funds occurred among the client’s
various bank accounts near the balance sheet date. All transfers of funds within
the organisation should be considered - whether among branches, divisions,
or affiliates - to make sure that cash is not “double counted” in two or more
bank accounts and that “kiting” has not occurred.
The auditor should determine:
(a) That each transaction represented as a transfer is in fact an authorised
transfer;
(b) That debits and credits representing transfers of cash are recorded in
the same period; and
(c) That the funds are actually deposited in the receiving bank in the
appropriate period.
Kiting is a way of concealing cash shortage caused by a defalcation, such as
misappropriating cash receipts that were perpetrated previously. It involves
the careful and deliberate use of the “float” (the time necessary for a cheque to
clear the bank it was drawn on). Drawing a cheque on one bank, depositing it
in another bank just before year-end, so that deposit appears on the bank
statement and the recording of the transfer in the receipts is not done until
after year-end amounts to kiting. The float period will cause the cheque not to
clear the bank it was drawn on until after year-end, and the amount transferred
is included in the balances of both bank accounts. Since the transfer is not
recorded as a receipt or a disbursement until the following year, it will not
appear as an outstanding cheque or a deposit in transit on the reconciliation of
either bank account. The effect is to increase receipts per the bank statement; if
the misappropriation of cash receipts and the kiting take place in the same
period, receipts per the bank statement will agree with receipt per the cash
receipts journal at the date of the bank reconciliation. (If the misappropriation
of cash receipts takes place in the period before the kiting, a proof of cash may
also reveal the kiting). Kiting requires that the transfer process be repeated
continually until the misappropriated funds have been restored. Kiting could
have a wider meaning to encompass writing cheques against inadequate funds
with the intent of depositing sufficient funds later, but before the cheques clear
the bank.
Bank transfer schedule is an effective tool that assists the auditor in ensuring
that:
(a) all transfers of funds among bank accounts near the balance sheet date
are recorded in the books in the proper accounting period;
(b) cash has not been double-counted; and
(c) there is no apparent kiting.
The schedule should indicate, for each transfer:
(a) The date the cheque affecting the transfer was recorded as a cash
disbursement;
(b) The date it was recorded as a cash receipt, the date it cleared the bank it
was drawn on; and
(c) The date it was deposited and cleared in the bank.
When kiting is suspected, the auditor should:
(a) Compile bank transfers and the client’s cash receipts and disbursement
records;
(b) Obtain dates on the bank transfer schedule from the cash records and
the dates on the cheque showing when it was received by the bank it
was deposited in and when it was paid by the bank it was drawn on;
(c) Compare date the cheque was recorded as a disbursement with the date
it was recorded as a receipt; the dates should be the same;
(d) If they are not and the entries are in different fiscal years, an adjusting
entry may be necessary to prevent double-counting of cash, depending
on the offsetting debit or credit to the entry that was made in the year
being audited;
(e) Compare the bank dates (paid and cleared) with the corresponding dates
the transaction was recorded in the books (received and disbursed) for
each transfer;
(f) If those dates are in different accounting periods, the transfer should
appear on the bank reconciliation as a reconciling item; and
(g) Lastly, investigate unusually long time lags between dates recorded
and dates for possible holding of cheques at year end - a cut-off problem.

Reviewing Cash Restrictions and Related Disclosures

The auditor should review the evidence previously obtained and, if necessary,
perform further procedures to ensure that all appropriate disclosures related
to cash have been made. The following may indicate restrictions on the
availability or use of cash that should be disclosed:
(a) Bank confirmations;
(b) Responses to inquiry letter;
(c) Loan agreements;
(d) Minutes of board of directors’ meetings; and
(e) Bond indentures.
Inquiry of client management may also indicate the need for disclosures of
cash balances that are restricted or the property of others. If the entity has
substantial funds in other countries or in foreign currencies, the auditor should
determine whether there are any restrictions on their availability and that
appropriate disclosures have been made.

Verification of Fixed Assets

Most businesses use fixed assets, e.g., property, plant, and equipment in the
process of generation of income. Expenditure to maintain or improve assets
acquired are normal. A major audit consideration is whether such expenditure
should be classified as expenses of current period or an addition to the cost of
assets.
The general rule is to capitalise expenditure if it will prolong the useful or
productive life of the asset into future periods. There should be proper distinction
between revenue and capital expenditure. Companies often have policies
defining which expenditure are to be capitalised. The auditor must exercise
judgement in determining whether the policies are appropriate and being
complied with.

Audit Objectives

The audit objectives for fixed assets are that:
(a) The fixed assets in the accounts exist;
(b) The fixed assets are owned or leased under capital leases by the entity;
(c) No material items were charged to expense that should have been
capitalised;
(d) Additions and disposals have been duly authorised and accurately
recorded;
(e) Cost or other basis of initially recording value is appropriate;
(f) Appropriate methods of depreciation have been applied, on a consistent
basis;
(g) The carrying value of fixed assets is appropriate in periods subsequent
to acquisition, considering such factors as utilisation, location and
technological changes; and
(h) Assets pledged as collateral are identified and properly disclosed.

Verification Methods

Obtain a schedule of each asset showing:
(a) Opening Balance
Review previous year’s working papers and the client’s records to
provide necessary understanding of the accounting principles, policies
and methods employed.
(b) Additions
(i) Examine purchase order and other supporting documents;
(ii) Vouch the cost vide invoices, cost includes all expenditures
necessary to make an asset ready for its intended use; and
(iii) Vouch the authority for acquisition by review of minutes of board
of directors or other committees to confirm whether major
additions were appropriately authorised.
(c) Disposals
(i) Vouch the authority;
(ii) Examine relevant documentation;
(iii) Compare acquisition cost with underlying records, re-compute
accumulated depreciation and the resulting gain/loss and
balancing charge/allowance;
(iv) Verify proceeds as reasonable;
(v) Pay attention to scrap value; and
(vi) Confirm proper accounting treatment.
(d) Depreciation and Other Write Downs
(i) Review client’s methods and policies;
(ii) Examine adequacy and appropriateness of policy;
(iii) Vouch authorisation policy;
(iv) Vouch revaluations ;
(v) Check calculations; and
(vi) Consider changes in business condition that may warrant reviews
of estimated useful life of the assets.
(e) The stated procedure must agree the physical assets to the closing Naira
value of the assets.
(f) Internal control procedures as regards additions, disposals, accounting
and maintenance of fixed assets are relevant. The auditor should also
make use of fixed assets registers.

Presentation, Disclosures and Value

(a) Accounting policies appropriate to the entity must be adopted. This must
be consistently applied and adequately disclosed;
(b) The entity must adhere to relevant Accounting Standards;
(c) Materiality in the context of the individual company must be considered;
(d) Proper classification of assets should be done;
(e) There should be proper disclosure and accurate description; and
(f) Clear distinction between capital and revenue is important. It could be
a matter of accounting policy - research and development - or matter of
opinion - repair expenditure is a charge against revenue, but may include
elements of improvement which is capital.

Other Matters Considered

(a) Letter of representation. Obtain management representation on carrying
values and classifications of fixed assets.
(b) Reasonableness and professional scepticism. Auditors should diligently
investigate and seek adequate assurance on the truth and fairness of
the financial statements. This he does with professional scepticism. If
therefore, he comes across anything that seems wrong, unlikely,
unreasonable, or suspicious, he is said to be “put upon enquiry”. In that
case he should diligently investigate the matter and be assured of the
truth of the matter.
(c) Assets pledged as collateral are identified and disclosed, along other
necessary disclosures.
(d) Appropriate depreciation methods are properly applied, on a basis
consistent with the previous year, to all items of assets that should be
depreciated.
(e) Taxation. Tax and capital allowances should be in accordance with the
asset accounts and the applicable laws.
(f) Insurance certificates of assets, e.g., motor vehicles, should be examined
to provide further corroborative proof of realising audit objectives.
(g) Assets leased under capital leases by the client are verified and properly
described.
(h) Assets held by third parties are equally included in the balance sheet
and properly described.

VERIFICATION OF LIABILITIES

Audit Objectives

The auditor should approach accrued liabilities with the view, that liabilities
are more likely to be understated or omitted from the accounts than overstated.
Therefore, audit objectives should focus on ascertaining that accrued liabilities
are not understated, but without ignoring the possibility that the opposite may
occur.
The auditor’s objectives in examining liability transactions and accounts are
to obtain reasonable assurance that:
(a) All obligations for amounts payable, long-term debt, and capitalised
leases and all equity accounts have been properly valued, classified,
described, and disclosed;
(b) All off-balance-sheet obligations have been identified and considered
(e.g., operating leases, product financing arrangements, build and
operate contracts, etc);
(c) All liability and equity transactions, accounts, and changes therein have
been properly authorised and are obligations of the entity or ownership
rights in the entity;
(d) Interest, discounts, premiums, dividends, and other debt-related and
equity-related transactions and accounts have been properly valued,
classified, described, and disclosed; and
(e) All terms, requirements, instructions, commitments, and other debtrelated
and equity-related matters have been identified, complied with
and disclosed, as appropriate.

Substantive Tests of Balances

A convenient way to document substantive tests of liabilities at balance sheet
date is obtaining or making detailed schedules of liabilities by categories,
owing the movement in each account during the period. The auditor should
compare the list with the accounts and reconcile the total to the general ledger.
Tests of details of debt and equity transactions and balances consist of obtaining
confirmations from third parties, re-performing computations, and examining
documents and records. The following are some examples:

Authorisation

(a) The auditor should trace authorisation to board minutes, or where such
authority was delegated, should be traced to the delegated officer’s
signature.
(b) Confirmations
Confirm debt payable and terms with holder; outstanding stock with
holder and registrar; and dividend and interest payable. Ensure the
recorded liabilities relate to values of goods and services received by
the entity.

Examination of Lease Documents

Terms in finance lease must be evaluated to determine whether it should be
accounted for as an operating or capital lease. If leases are capitalised, the
auditor must test computations of the carrying amounts of assets and debt,
and compare them with the underlying lease contract.

Rights and Obligations

(a) Ascertain that all accounts payables, accrued expenses and other
liabilities are legal obligations of the entity at the balance sheet date;
(b) Check presentation and disclosure as to amount falling due within or
after one year; and
(c) Consider the description and classification of liabilities in the financial
statements. If material loss could arise from unfulfiled purchase
commitments, the auditor should identify the commitments and assess
the potential need for a provision. In all, the auditor should ensure
compliance with all statutory provisions and other accounting requirements.

Letter of Representation

Management must explicitly assert the existence, rights and obligations,
completeness and appropriate presentation, and disclosure in the financial
statements. These assertions are made in a letter of representation.

Inclusion of all Liabilities

It is not enough for the auditor to be satisfied that all the liabilities recorded in
the books are correct and are incorporated in the financial’ statements. Auditors
must be satisfied that there are no unrecorded liabilities, transactions or
undisclosed items. The auditor should appreciate the possibilities of the
existence of undisclosed liabilities. He also has an obligation to take reasonable
steps to unearth them.
The auditors discharge these obligations by:
(a) Diligently enquiring of the directors and other officers and by obtaining
letter of representation;
(b) Examining post balance sheet events, where applicable; and
(c) Examining minutes of meeting of the board and management where
the existence of unrecorded liabilities may be mentioned.

Provisions

A clear understanding of the words - provision and reserves - is imperative.
The correct usages of these two words are:
Provision - any amount retained as reasonably necessary for the purpose of
providing for any liability or loss which is either likely to be incurred, or certain
to be incurred but uncertain as to amount or as to the date on which it will
arise.
Thus a provision:
(a) Is a debit to profit and loss account reducing profit and therefore
dividends;
(b) Is in respect of a likely or certain future payment; and
(c) Arises where the amount or the rate of payment is uncertain.
Reserve - that part of shareholders’ funds not accounted for by the nominal
value of issued share capital or by the share premium account.
The need for the creation of provisions is an important consideration for directors
who are responsible for the financial statements. Post balance sheet events
can often give an indication of the amount of provision required. The auditor
has a duty to see that any provisions set up are used for the purpose for which
they were set up and that any provisions, which are no longer needed, are
written back to profit and loss account.
Items should be provided for, only when the company has a firm commitment
(not merely an intention) to the expenditure. It should be noted that the only
costs to be provided for should be those incremental costs necessary to sort out
a past problem. Any costs that will bring benefits in the future should be charged
in the future period.

Share Capital

When there are new issues
Share capital is a special sort of liability of a company. When share capital has
been issued during the year, auditors should:
(a) Ensure that the issue is within the limits authorised by Memorandum
and Articles of Association of the entity;
(b) Ensure that the issue was subject to directors’ minutes and shareholders’
approval, where applicable;
(c) Ascertain and evaluate the system for the control of issue; and
(d) Verify that the system has been properly operated. This will involve
examining the prospectus (where applicable), application and allotment
sheets, the share register, cash received records, share certificate
counterfoils, and refunds to unsuccessful applicants.
Where Stock Exchange approval was required, the auditors should:
(a) Ensure that permission has been obtained. If it has not been given all
the money subscribed is returnable;
(b) Ensure that all the money is maintained in a separate bank account
until all conditions were satisfied;
(c) Ensure that the minimum subscription has been received. If there are
not enough subscribers then the whole amount is returnable; and
(d) Vouch the payment of underwriting and other fees.
Where there are no new issues
When no new issue of shares has been made, the auditor should:
(a) Determine the total of shares of each class as stated in the balance sheet
and obtain a list of shareholdings, which in total should agree with the
balance sheet total;
(b) Test the balances in the share register with the list;
(c) If this is not possible at the balance sheet date, it may be permissible to
do it earlier provided that the auditor is satisfied with the system of
control over transfers; and
(d) Where the share register is maintained by an independent firm of
registrars, the auditor should obtain a certificate as to the accuracy and
completeness of the shares and their holdings. The certificate should
state that the balances on the share registers agree with the issued
capital at the balance sheet date.

Accounting Estimates

An important aspect of evaluating the application of accounting principles,
particularly as they relate to the valuation objective for many accounts, involves
evaluating accounting estimates. Accounting estimates are:
(a) Financial statement approximations that are necessary because the
measurement of an account is uncertain until the outcome of future events
is known, e.g., uncollectible receivables, obsolete inventory, useful lives
of assets, actuarial assumptions in pension plans, and warranty claims;
and
(b) Financial statement approximations that come about in respect of
relevant data concerning events which could not be accumulated on a
timely, cost-effective basis.
Examples of accounting estimates are:
(a) Allowances to reduce inventory and accounts receivable to their
estimated realisable value;
(b) Provisions to allocate the cost of fixed assets over their estimated useful
lives;
(c) Accrued revenue;
(d) Deferred tax;
(e) Provision for a loss from a lawsuit;
(f) Losses on construction contracts in progress; and
(g) Provision to meet warranty claims.
Management is responsible for making the accounting estimates whilst the
auditor is to evaluate their reasonableness. Even when management’s
estimating process involves competent personnel using relevant and reliable
data and the most likely assumptions about the factors that affect an accounting
estimate, subjectivity can still creep into those estimates which in turn may
lead to bias. As a result, the auditor should evaluate accounting estimates
with an attitude of professional scepticism. The auditor’s objective in evaluating
accounting estimates is to obtain sufficient evidence to provide reasonable
assurance that all material accounting estimates have been developed, are
reasonable, and are presented and disclosed in conformity with the Nigerian
Standards on Auditing.

Basic Approaches to Establish Reasonableness of an Estimate

The auditor should use any or a combination of these basic approaches in
assessing the reasonableness of an estimate, viz:
(a) Review and test the process management used to develop the estimate;
(b) Independently develop an expectation of the estimate to corroborate
the reasonableness of management’s estimate; and
(c) Review events or transactions occurring after the date of the financial
statements (but before the audit is completed) that provide an actual
amount to compare the estimate with.
In the application of the approach in (a) above, the auditor should:
(a) Obtain an understanding of the process management established to
develop the estimate;
(b) Assess the inherent and control risks related to management’s process
for developing the estimate; and
(c) Identify and evaluate the key factors and assumptions used by
management to formulate the estimate.
The following are helpful procedures to identify and evaluate the key factors
and assumptions that are unique to auditing accounting estimates:
(a) Analysing historical data used in developing the assumptions to assess
whether it is comparable and consistent with data of the period under
audit, and determining whether it is sufficiently reliable;
(b) Considering whether changes in the business or industry or in other facts
or circumstances may cause factors different from those considered in
the past to become significant to the accounting estimate;
(c) Reviewing available documentation of the assumptions used in
developing the accounting estimate, and inquiring about any other
relevant plans, goal, and objectives of the entity; and considering their
relationship to the assumptions;
(d) Evaluating whether the assumptions are consistent with one another,
with the supporting data, and with relevant historical data;
(e) Concentrate on those key factors and assumptions that are:
(i) Material to the estimate;
(ii) Sensitive to variations; and
(iii) Subject to deviations from historical patterns.
(f) Considering using the work of a specialist.
When errors or irregularities are found as a result of substantive tests, the auditor
should ascertain the reason for them and consider the implications.

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VERIFICATION OF CURRENT ASSETS AND LIABILITIES