MAH, Chartered Accountants

Author: Mohammed Haque

  • How to audit trade payables

    To audit trade payables, the auditor should perform the following steps:

    1. Understand the entity’s trade payables and the related business processes: The auditor should obtain an understanding of the entity’s trade payables, including the nature, timing, and amount of the payables, and the related business processes, such as the purchasing and payment processes.
    2. Assess the risks of material misstatement in the trade payables: The auditor should assess the risks of material misstatement in the trade payables, taking into account the entity’s industry, the economic environment, the credit quality of the entity’s suppliers, and the entity’s internal controls.
    3. Develop an audit plan and audit procedures for the trade payables: Based on the understanding of the trade payables and the risks of material misstatement, the auditor should develop an audit plan and audit procedures for the trade payables, including the nature, timing, and extent of the audit procedures.
    4. Test the trade payables and evaluate the results: The auditor should test the trade payables and evaluate the results, using appropriate audit procedures, such as confirmation, observation, inspection, and recalculation. The auditor should also evaluate the entity’s accounting policies and estimates related to the trade payables, such as the accrual of unpaid expenses.
    5. Conclude on the trade payables and communicate the findings: Based on the audit evidence obtained, the auditor should conclude on the trade payables and communicate the findings to the entity’s management and the audit committee. The auditor should also evaluate the entity’s disclosure of the trade payables in the financial statements.

  • How to audit trade receivables

    To audit trade receivables, the auditor should perform the following steps:

    1. Understand the entity’s trade receivables and the related business processes: The auditor should obtain an understanding of the entity’s trade receivables, including the nature, timing, and amount of the receivables, and the related business processes, such as the sales and billing processes.
    2. Assess the risks of material misstatement in the trade receivables: The auditor should assess the risks of material misstatement in the trade receivables, taking into account the entity’s industry, the economic environment, the credit quality of the entity’s customers, and the entity’s internal controls.
    3. Develop an audit plan and audit procedures for the trade receivables: Based on the understanding of the trade receivables and the risks of material misstatement, the auditor should develop an audit plan and audit procedures for the trade receivables, including the nature, timing, and extent of the audit procedures.
    4. Test the trade receivables and evaluate the results: The auditor should test the trade receivables and evaluate the results, using appropriate audit procedures, such as confirmation, observation, inspection, and recalculation. The auditor should also evaluate the entity’s accounting policies and estimates related to the trade receivables, such as the allowance for doubtful accounts.
    5. Conclude on the trade receivables and communicate the findings: Based on the audit evidence obtained, the auditor should conclude on the trade receivables and communicate the findings to the entity’s management and the audit committee. The auditor should also evaluate the entity’s disclosure of the trade receivables in the financial statements.

  • Sampling in audits

    In auditing, sampling is the process of selecting a subset of items or transactions from a population for the purpose of testing and evaluating the population. Sampling is used in auditing to provide the auditor with sufficient appropriate audit evidence to support the audit opinion, while avoiding the need to test and evaluate the entire population.

    There are two types of sampling methods used in auditing: statistical sampling and non-statistical sampling. Statistical sampling involves the use of mathematical techniques and probabilities to determine the sample size and the selection of items in the sample. Non-statistical sampling involves the use of the auditor’s professional judgment to determine the sample size and the selection of items in the sample.

    In statistical sampling, the sample size and the selection of items in the sample are determined based on the auditor’s desired level of precision and the expected population characteristics, such as the expected mean and the expected standard deviation. The auditor uses statistical formulas and tables to determine the sample size and the selection of items in the sample, and to evaluate the results of the sample.

    In non-statistical sampling, the sample size and the selection of items in the sample are determined based on the auditor’s professional judgment and experience, taking into account the nature of the population, the auditor’s assessment of the risks of material misstatement, and the auditor’s overall audit strategy. The auditor uses the sample to evaluate the population, and may use statistical techniques to evaluate the results of the sample.

    Overall, sampling is an important concept in auditing, as it allows the auditor to obtain sufficient appropriate audit evidence to support the audit opinion, while avoiding the need to test and evaluate the entire population. The use of sampling in auditing requires the auditor to have a deep understanding of statistical techniques and probabilities, as well as the ability to use professional judgment and experience to determine the sample size and the selection of items in the sample.

    Impact on audit work

    For a small population it may be difficult to use statistical sampling, so we would normally use our judgement to pick the sample size and items, mainly picking risky/large items as well as a few other small items to ensure we cover a cross section of the population.

    For a large population we would normally use the sample calculator to calculate the sample size, after selecting large and risky items. The results of the sample test can then be projected to the population.

  • Trivial errors

    In auditing, the concept of trivial refers to an item or matter that is insignificant or immaterial, and therefore does not require further attention or audit procedures.

    An item or matter is considered trivial if it is small in relation to the overall size and nature of the financial statements, and if it does not have a significant impact on the financial statements. An item or matter is considered trivial if it is not material, and if it is not indicative of a potential material misstatement or error in the financial statements.

    The determination of triviality is based on the auditor’s professional judgment, and takes into account the auditor’s assessment of the risks of material misstatement and the auditor’s tolerance for misstatements in the financial statements. The determination of triviality should be made on a case-by-case basis, and should be documented in the audit working papers.

    For example, if an auditor is reviewing the accounts payable balance for an entity, and the auditor determines that a small account payable balance of $50 is not material and does not have a significant impact on the financial statements, the auditor may consider the account payable balance to be trivial and may not perform further audit procedures on the account.

    Overall, the concept of triviality is an important concept in auditing, as it allows the auditor to focus on items or matters that are significant or material, and to avoid spending unnecessary time and resources on immaterial items or matters. The determination of triviality should be based on the auditor’s professional judgment, and should be documented in the audit working papers.

  • Materiality

    Materiality and performance materiality are important concepts in auditing and financial reporting, as they help to determine the nature, timing, and extent of the audit procedures and the disclosures in the financial statements.

    Materiality refers to the significance of an item or matter to the financial statements. An item or matter is material if its omission or misstatement could reasonably be expected to influence the economic decisions of the users of the financial statements. Materiality depends on the size and nature of the item or matter, and the surrounding circumstances.

    Performance materiality is the level of misstatement in the financial statements that the auditor is willing to accept without modifying the audit opinion, taking into account the auditor’s assessment of the risks of material misstatement and the auditor’s professional judgment. Performance materiality is typically set at a lower level than materiality, as it reflects the auditor’s tolerance for misstatements in the financial statements.

    There are several benchmarks that can be used to determine materiality and performance materiality, including the relative size of the item or matter, the nature of the item or matter, and the overall size and nature of the financial statements.

    For example, the relative size of the item or matter can be used as a benchmark for materiality and performance materiality. An item or matter with a large relative size, such as a significant transaction or account balance, is more likely to be material than an item or matter with a small relative size.

    The nature of the item or matter can also be used as a benchmark for materiality and performance materiality. An item or matter with a significant impact on the financial statements, such as a transaction that affects the entity’s revenue or expenses, is more likely to be material than an item or matter with a limited impact on the financial statements.

    The overall size and nature of the financial statements can also be used as a benchmark for materiality and performance materiality. For example, an item or matter that represents a large percentage of the entity’s total assets or revenue is more likely to be material for a small entity than for a large entity.

    Overall, materiality and performance materiality are important concepts in auditing and financial reporting, as they help to determine the nature, timing, and extent of the audit procedures and the disclosures in the financial statements. There are several benchmarks that can be used to determine materiality and performance materiality, including the relative size of the item or matter, the nature of the item or matter, and the overall size and nature of the financial statements.

    Typical Benchmarks

    Range of turnover or gross assetsPercentage of turnover or gross assetsMateriality ranges
    £0 –    £500,0003.00%£1 – £15,000
    £500,001 – £2,000,0002.50%£15,001 – £50,000
    £2,000,001 – £3,500,0002.00%£50,001 – £70,000
    £3,500,001 – £6,000,0001.50%£70,001 – £90,000
    over £6,000,0001.00%over £90,000

    Performance materiality

    For low risk engagements, performance materiality is generally calculated around 75%-80% of materiality.

    For high risk, it may be around 60%.

    Trivial

    We would normally use 5% of materiality to calculate the level below which misstatements are considered to be trivial.

  • Audit assertions under the ISAs

    Audit assertions are the statements made by the management of an entity about the financial statements, and are the basis for the auditor’s audit procedures and conclusions. The International Standards on Auditing (ISAs) specify certain audit assertions that the auditor should consider when planning and performing the audit, in order to obtain sufficient appropriate audit evidence.

    The ISAs specify three types of audit assertions: presentation and disclosure assertions, transaction and event assertions, and assertion about account balances.

    Presentation and disclosure assertions relate to the overall presentation and disclosure of the financial statements, and include assertions such as the completeness of the financial statements, the classification of transactions and events, and the accuracy and completeness of the disclosures.

    Transaction and event assertions relate to the recognition, measurement, and presentation of transactions and events, and include assertions such as the accuracy and completeness of the transactions, the existence and occurrence of the transactions, and the rights and obligations of the entity arising from the transactions.

    Assertions about account balances relate to the accuracy and completeness of the account balances in the financial statements, and include assertions such as the accuracy and completeness of the account balances, the valuation and allocation of assets and liabilities, and the presentation and disclosure of the account balances.

    The auditor should consider the relevant audit assertions when planning and performing the audit, in order to obtain sufficient appropriate audit evidence to support the audit opinion. The audit assertions should be discussed with the management of the entity, and any significant assumptions and estimates used by the management should be assessed by the auditor.

  • Intangible assets (IAS 38)

    International Accounting Standard (IAS) 38, “Intangible Assets,” provides guidance on the recognition, measurement, and disclosure of intangible assets. IAS 38 applies to all intangible assets, except for certain intangible assets that are specifically excluded from the scope of the standard, such as financial instruments, deferred tax assets, and assets arising from employee benefits.

    IAS 38 defines an intangible asset as an identifiable non-monetary asset without physical substance. An intangible asset is identifiable if it is separable, meaning that it can be sold, transferred, licensed, or exchanged separately from the entity’s other assets. An intangible asset is non-monetary if it cannot be measured in terms of money.

    Intangible assets are required to be recognized as assets if they meet certain criteria, including the criterion that they are identifiable and meet the definition of an intangible asset. Intangible assets that are recognized as assets are required to be measured at cost less accumulated amortization and accumulated impairment losses, unless they are measured at fair value through profit or loss.

    Intangible assets with finite useful lives are required to be amortized over their useful economic lives, which is the period over which the assets are expected to generate economic benefits for the entity. The amortization period should be determined based on the expected pattern of consumption of the economic benefits of the assets, taking into account the nature of the assets and the entity’s expected future use of the assets.

    Intangible assets with indefinite useful lives are not amortized, but are required to be tested for impairment at least annually, or more frequently if there are indicators of impairment. The impairment test for intangible assets with indefinite useful lives involves comparing the carrying value of the assets to their recoverable amount. The recoverable amount is the higher of the assets’ fair value less costs to sell and their value in use.

    Intangible assets that are measured at fair value through profit or loss are required to be recognized at fair value at the date of acquisition, with any subsequent changes in fair value recognized in profit or loss in the period in which they arise. Intangible assets measured at fair value through profit or loss are not amortized, but are tested for impairment in the same way as intangible assets with indefinite useful lives.

    Disclosure of intangible assets is required in the financial statements, including information about the carrying amount, amortization, and impairment of intangible assets. The financial statements should also disclose any relevant assumptions and estimates used in determining the useful lives and impairment of intangible assets.

  • Share issue transaction costs

    Share issue transaction costs are costs incurred by a company in connection with issuing new shares. Share issue transaction costs can include costs such as legal fees, accounting fees, printing costs, and broker fees.

    Share issue transaction costs are usually required to be recognized as a deduction from equity (FRS 102 s22.9 and IAS 32 s37) and are usually offset against share premium.

  • Goodwill

    Goodwill is an intangible asset that arises when one entity acquires another entity and pays more than the fair value of the acquired entity’s net assets. Goodwill is typically assigned to a cash-generating unit (CGU), which is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

    Goodwill is required to be tested for impairment at least annually, or more frequently if there are indicators of impairment. The impairment test for goodwill involves comparing the carrying value of the goodwill to its recoverable amount. The recoverable amount is the higher of the goodwill’s fair value less costs to sell and its value in use.

    The value in use of goodwill is the present value of the future cash flows expected to be generated by the CGU to which the goodwill is assigned. The future cash flows should be based on the entity’s best estimate of the CGU’s future cash flows, taking into account the entity’s plans and assumptions about future market conditions, competition, and other factors. The future cash flows should be discounted at a rate that reflects the risks associated with the cash flows.

    If the carrying value of the goodwill exceeds its recoverable amount, the goodwill is impaired and the entity must recognize an impairment loss. The impairment loss is the difference between the carrying value of the goodwill and its recoverable amount. The impairment loss should be recognized in the income statement as an expense, and the carrying value of the goodwill should be reduced to its recoverable amount.

    For example, if an entity has goodwill with a carrying value of £500,000 assigned to a CGU, and the recoverable amount of the goodwill is determined to be £450,000, the goodwill is impaired and the entity must recognize an impairment loss of £50,000. The impairment loss of £50,000 would be recognized as an expense in the income statement, and the carrying value of the goodwill would be reduced to £450,000.

    Goodwill relating to a foreign subsidiary would need to be re-translated at each year end, with the exchange gain/loss recognised in an FX equity reserve relating to the subsidiary.

  • Restrospective correction of prior period errors

    A retrospective correction of prior period errors is a correction of errors that occurred in a previous period, but were not discovered until a subsequent period. Retrospective correction of prior period errors is required by IAS 8 and also FRS 102 s10.21 which state that errors should be corrected retrospectively by adjusting the opening balance of retained earnings for the earliest period presented.

    To correct a prior period error retrospectively, the entity should first determine the amount of the error and the period in which the error occurred. The entity should then adjust the opening balance of retained earnings for the earliest period presented in the financial statements, by the amount of the error and a corresponding adjustment to the appropriate item in the statement of financial position.

    For example, if an entity discovers a material £50,000 error in the calculation of opening balances for prepayments carried forward from 2022 during the audit of 2023, the entity would need to correct the error retrospectively. The other side of the entry would be to adjust the opening balance of retained earnings carried forward from 2022.

    The journal in 2023 would be:
    Dr prepayments £50,000
    Cr retained earnings b/fwd £50,000

    The comparatives column in the 2023 accounts would also be restated and the error would need to be disclosed.