Audit of Specific Financial Statement Areas

🟢 Lite — Quick Review (1h–1d)

Audit of Specific Areas — Key Facts

Receivables:

• Direct confirmation (positive/negative) — primary procedure
• Age analysis review — test for bad debt provision
• Subsequent cash receipts testing — existence, valuation

Inventory:

• Attend physical inventory count (observation)
• Cut-off testing (movement around year-end)
• Net Realizable Value (NRV) — lower of cost and NRV

Property, Plant & Equipment (PPE):

• Physical inspection
• Vouching to supporting documents (invoice, title deeds)
• Depreciation review — useful life, method, residual value
• Capital vs Revenue expenditure distinction

Payables & Provisions:

• Supplier statement reconciliation
• Completeness testing (unrecorded liabilities)
• Legal confirmation for contingent liabilities

⚡ Exam Tip: For inventory — ALWAYS mention NRV test. For PPE — ALWAYS distinguish capital expenditure (asset) from revenue expenditure (expense). These are high-frequency exam traps.

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🟡 Standard — Regular Study (2d–2mo)

Audit of Specific Areas — Detailed Content

Receivables — Substantive Procedures:

Assertions tested: Existence, completeness, valuation, rights & obligations, cut-off, presentation

Procedure	What It Tests
Receivables confirmation	Existence + rights
Age analysis review	Valuation (bad debt provision)
Subsequent cash receipts	Existence + valuation
Cut-off testing	Cut-off (sales and receipts)
Specific bad debt write-off	Valuation
Related party review	Occurrence + disclosure

Positive vs Negative Confirmation:

• Positive: Client expects response; no reply = exception
• Negative: Only reply if disagreement; cheaper but less reliable
• Use positive for material/high-risk balances

Inventory — Substantive Procedures:

Key Procedures:

1. Attend inventory count (observation) — auditor must attend year-end counts

   • Observe count procedures
   • Perform independent recount (selective)
   • Note damaged/excess/slow-moving items

2. Cut-off testing:

   • Goods received notes (GRN) before year-end → included in inventory?
   • Dispatch notes after year-end → excluded from inventory?
   • Sales invoices cut-off → revenue recognized in correct period?

3. NRV Testing:

   NRV = Estimated Selling Price − Estimated Cost to Complete − Selling Costs
   
   If NRV < Cost → Write down inventory to NRV (ISA 2/IAS 2)

4. Inventory count attendance alternatives (if not attending):

   • Rolls-Royce test (roll back inventory from count date to year-end)
   • Combination of internal controls + substantive testing

PPE — Substantive Procedures:

Procedure	Assertion
Physical inspection	Existence
Title deeds, ownership documents	Rights & Obligations
Vouching additions	Occurrence, accuracy
Review of disposals	De-recognition, gain/loss
Depreciation schedule review	Valuation (wear & tear)
Impairment review	Valuation
Capital vs Revenue test	Classification

Capital vs Revenue Expenditure:

• Capital: Adds to future economic benefits, enhances asset (→ assetize)
• Revenue: maintains existing benefits (→ expense)

Payables & Creditors:

Procedure	Purpose
Supplier statement reconciliation	Completeness + accuracy
Confirmation of balances	Existence
Cut-off testing (purchases)	Cut-off
Post-year-end payments	Completeness (window procedure)
Legal confirmation	Contingent liabilities
-review	Completeness (provisions)

⚡ Exam Tip: “Completeness” is the KEY assertion for payables — they’re often understated. Use “unrecorded liabilities” testing (examine post-year-end invoices, supplier statements, requests for payment).

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🔴 Extended — Deep Study (3mo+)

Comprehensive Audit of Specific Areas Notes

Receivables — Deep Dive:

Bad Debt Provision Assessment:

Step 1: Obtain age analysis of receivables
Step 2: Identify overdue accounts
Step 3: Review subsequent cash receipts (after year-end)
Step 4: Evaluate customer creditworthiness (public info, management assessment)
Step 5: Review correspondence (disputes, disputes)
Step 6: Calculate required provision
Step 7: Compare to existing provision → adjust if needed

Debt Factoring/Invoice Discounting:

• If receivables are sold/discounted, auditor must verify:
  • Derecognition criteria met (IAS 39/IFRS 9)?
  • Contingent liability disclosed?
  • Audit work on recourse provisions

Inventory — NRV Worked Example:

Example:
Historical Cost: Rs. 100 per unit
Estimated Selling Price: Rs. 85
Estimated Cost to Complete: Rs. 10
Selling Costs: Rs. 5

NRV = 85 − 10 − 5 = Rs. 70

Since NRV (70) < Cost (100):
Inventory should be stated at Rs. 70 per unit
Write-down = Rs. 30 per unit → charged to P&L

Inventory Count Procedures Checklist:

Before Count:
□ Confirm date and location with client
□ Plan attendance (timing, areas to cover)
□ Issue instructions to inventory team

During Count:
□ Observe count procedures
□ Perform independent test counts
□ Note damaged/excess/slow-moving items
□ Obtain count sheets
□ Trace items to count sheets

After Count:
□ Agree count sheets to inventory master
□ Review cut-off (GRN, dispatch notes)
□ Review NRV and slow-moving provision
□ Review obsolescence reserve

PPE — Revaluation Model vs Cost Model:

Under IAS 16:

• Cost Model: Carrying Amount = Cost − Accumulated Depreciation − Impairment
• Revaluation Model: Carrying Amount = Fair Value − Subsequent Depreciation

If revalued:

• Revaluation gain → OCI (Other Comprehensive Income) → Revaluation surplus in equity
• Revaluation loss → P&L (if exceeds previous revaluation gain)

Depreciation — Audit Checkpoints:

• Review useful life estimates (compare to asset nature, industry norms)
• Review residual value (is it realistic?)
• Review depreciation method (straight-line vs reducing balance vs units of production)
• Check depreciation policy applied consistently
• Verify no depreciation on fully depreciated assets still in use
• Verify depreciation calculated from date of acquisition/decommissioning

Provisions and Contingencies (ISA 501/IFRS/ISA 450):

Provisions: Present obligation, probable outflow, reliable estimate Contingent Liabilities: Possible obligation OR present obligation but not probable → DISCLOSURE (not provision)

Three Scenarios for Contingent Liabilities:

Scenario	Treatment
Probable + reliably measurable	Recognize as PROVISION
Probable but not reliably measurable	DISCLOSURE in notes
Possible or remote	DISCLOSURE (possible) or No disclosure (remote)

Auditor’s Procedures for Provisions:

• Review board minutes
• Obtain legal confirmation (confirm with client’s lawyers)
• Review correspondence with legal advisors
• Analyze tax provisions
• Consider going concern implications

Common Exam Mistakes:

Mistake	Correction
”Inventory counted = existence confirmed”	Must also verify ownership (goods on consignment?) and NRV
”PPE at cost = correct”	Must verify cost includes ALL items to bring asset to working condition
”No bad debts written off = provision adequate”	Review age analysis and subsequent receipts — provision may still be understated
”Payables agree to trial balance = no issue”	Must test completeness — unrecorded liabilities are the real risk

⚡ High-Yield Audit Programme Summary:

Receivables Audit Programme:

1. Obtain/reconcile receivables sub-ledger to general ledger
2. Obtain age analysis and review
3. Confirm receivables (positive confirmation)
4. Test subsequent cash receipts
5. Review bad debt write-offs
6. Review credit notes post year-end
7. Test cut-off (sales and receipts)

Inventory Audit Programme:

1. Attend physical count (or perform roll-forward)
2. Obtain count sheets and agree to inventory master
3. Perform test counts
4. Review slow-moving and obsolete provision
5. Test NRV calculations
6. Test cut-off (GRN, dispatch notes, sales invoices)
7. Review inventory accounting policies

⚡ Exam Answer Framework:

For each area, structure answer:

1. Identify key assertions at risk
2. Select appropriate substantive procedures
3. Explain what each procedure tests (link to assertion)
4. Evaluate findings (what adjustments might be needed?)
5. Conclude on whether assertions are satisfied

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