ICAI Notes: Audit of Items of Financial Statements | Auditing and Ethics for CA Intermediate PDF Download

 Page 1


a
    
 
 
CHAPTER 
5 
 
 
LEARNING OUTCOMES 
  
 
 
 AUDIT OF ITEMS OF 
FINANCIAL 
STATEMENTS 
 
 
 
After studying this chapter, you would be able to understand- 
? The general considerations in an audit of financial 
statements. 
? The specific procedures for auditing heads of balance sheet 
and statement of profit or loss. 
? Audit procedures in respect of certain disclosures in the 
financial statements. 
? Practicality of above concepts using examples and case 
studies. 
 
© The Institute of Chartered Accountants of India
Page 2


a
    
 
 
CHAPTER 
5 
 
 
LEARNING OUTCOMES 
  
 
 
 AUDIT OF ITEMS OF 
FINANCIAL 
STATEMENTS 
 
 
 
After studying this chapter, you would be able to understand- 
? The general considerations in an audit of financial 
statements. 
? The specific procedures for auditing heads of balance sheet 
and statement of profit or loss. 
? Audit procedures in respect of certain disclosures in the 
financial statements. 
? Practicality of above concepts using examples and case 
studies. 
 
© The Institute of Chartered Accountants of India
a
 
 
AUDITING AND ETHICS  
 
5.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement 
INCOME STATEMENT CAPTIONS COMPRISING REVENUE AND EXPENSE BALANCES 
Occurrence 
Completeness 
Cut off 
Presentation & 
Disclosure 
BALANCE SHEET CAPTIONS COMPRISING ASSETS, LIABILITIES AND EQUITY 
BALANCES 
 
Existence 
Completeness 
Cut off Valuation 
Rights & 
Obligations 
Presentation 
& Disclosure 
CHAPTER OVERVIEW 
 
W
© The Institute of Chartered Accountants of India
Page 3


a
    
 
 
CHAPTER 
5 
 
 
LEARNING OUTCOMES 
  
 
 
 AUDIT OF ITEMS OF 
FINANCIAL 
STATEMENTS 
 
 
 
After studying this chapter, you would be able to understand- 
? The general considerations in an audit of financial 
statements. 
? The specific procedures for auditing heads of balance sheet 
and statement of profit or loss. 
? Audit procedures in respect of certain disclosures in the 
financial statements. 
? Practicality of above concepts using examples and case 
studies. 
 
© The Institute of Chartered Accountants of India
a
 
 
AUDITING AND ETHICS  
 
5.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement 
INCOME STATEMENT CAPTIONS COMPRISING REVENUE AND EXPENSE BALANCES 
Occurrence 
Completeness 
Cut off 
Presentation & 
Disclosure 
BALANCE SHEET CAPTIONS COMPRISING ASSETS, LIABILITIES AND EQUITY 
BALANCES 
 
Existence 
Completeness 
Cut off Valuation 
Rights & 
Obligations 
Presentation 
& Disclosure 
CHAPTER OVERVIEW 
 
W
© The Institute of Chartered Accountants of India
 
 
AUDIT OF ITEMS OF FINANCIAL STATEMENTS
 
 5.3 
Full import of “Substantive audit procedures” was already ingrained by Sameer. 
However, he wanted to know how such procedures are actually applied. How such 
detailed checking is carried out by team carrying out audit? Are there separate 
yardsticks for verifying “transactions” and “balances”? And what is logic behind 
detailed checking of “transactions” and “balances”? Recalling the basic premise of 
preparation of financial statements by the management, it flowed to him logically 
that such preparation of financial statements ought to involve expressly stated or 
implied statements. While carrying out detailed checking, auditor basically tries to 
verify these assertions. 
Shekhar had told him that while verifying transactions and balances of the 
manufacturing company they were auditing, all assertions backing up these were 
verified. For example, while verifying sales of the company, it was verified that sales 
pertaining to the company have, in fact, taken place. It was also verified that data 
in respect of these transactions was recorded correctly. Nonetheless, it was made 
sure to verify recording of transactions in correct accounting period. And there 
were others too!  
Similarly, while verifying trade receivables, procedures were applied to confirm 
existence of these balances. It was also checked that money represented by trade 
receivables was, in fact, recoverable. Were some balances under litigation or under 
dispute? All such aspects were gone through to obtain assurance that the balances 
were properly valued. And how can disclosure requirements be left behind? 
Whether all disclosures have been made in respect of such balances which were 
required to be made in accordance with applicable financial reporting framework? 
Besides this, analytical procedures also needed to be performed to bring out 
variations and fluctuations. 
Gathering that transactions and balances reflected in financial statements convey 
so many things, both stated and understood, he found such a framework quite 
logical. In this context, requirements of applicable financial reporting framework 
become too important to be taken lightly. Schedule III of Companies Act, 2013 
came to his mind instantaneously in context of their talks pertaining to a 
manufacturing company. 
Performing audit procedures to verify such assertions provides evidence to auditor 
which is evaluated in light of overall circumstances. Such procedures are indeed 
bedrock which help auditor to crystallize his opinion in form of audit report. 
Wanting to learn comprehensively about such procedures particularly in context of 
companies, he scrolled mouse to next page. 
© The Institute of Chartered Accountants of India
Page 4


a
    
 
 
CHAPTER 
5 
 
 
LEARNING OUTCOMES 
  
 
 
 AUDIT OF ITEMS OF 
FINANCIAL 
STATEMENTS 
 
 
 
After studying this chapter, you would be able to understand- 
? The general considerations in an audit of financial 
statements. 
? The specific procedures for auditing heads of balance sheet 
and statement of profit or loss. 
? Audit procedures in respect of certain disclosures in the 
financial statements. 
? Practicality of above concepts using examples and case 
studies. 
 
© The Institute of Chartered Accountants of India
a
 
 
AUDITING AND ETHICS  
 
5.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement 
INCOME STATEMENT CAPTIONS COMPRISING REVENUE AND EXPENSE BALANCES 
Occurrence 
Completeness 
Cut off 
Presentation & 
Disclosure 
BALANCE SHEET CAPTIONS COMPRISING ASSETS, LIABILITIES AND EQUITY 
BALANCES 
 
Existence 
Completeness 
Cut off Valuation 
Rights & 
Obligations 
Presentation 
& Disclosure 
CHAPTER OVERVIEW 
 
W
© The Institute of Chartered Accountants of India
 
 
AUDIT OF ITEMS OF FINANCIAL STATEMENTS
 
 5.3 
Full import of “Substantive audit procedures” was already ingrained by Sameer. 
However, he wanted to know how such procedures are actually applied. How such 
detailed checking is carried out by team carrying out audit? Are there separate 
yardsticks for verifying “transactions” and “balances”? And what is logic behind 
detailed checking of “transactions” and “balances”? Recalling the basic premise of 
preparation of financial statements by the management, it flowed to him logically 
that such preparation of financial statements ought to involve expressly stated or 
implied statements. While carrying out detailed checking, auditor basically tries to 
verify these assertions. 
Shekhar had told him that while verifying transactions and balances of the 
manufacturing company they were auditing, all assertions backing up these were 
verified. For example, while verifying sales of the company, it was verified that sales 
pertaining to the company have, in fact, taken place. It was also verified that data 
in respect of these transactions was recorded correctly. Nonetheless, it was made 
sure to verify recording of transactions in correct accounting period. And there 
were others too!  
Similarly, while verifying trade receivables, procedures were applied to confirm 
existence of these balances. It was also checked that money represented by trade 
receivables was, in fact, recoverable. Were some balances under litigation or under 
dispute? All such aspects were gone through to obtain assurance that the balances 
were properly valued. And how can disclosure requirements be left behind? 
Whether all disclosures have been made in respect of such balances which were 
required to be made in accordance with applicable financial reporting framework? 
Besides this, analytical procedures also needed to be performed to bring out 
variations and fluctuations. 
Gathering that transactions and balances reflected in financial statements convey 
so many things, both stated and understood, he found such a framework quite 
logical. In this context, requirements of applicable financial reporting framework 
become too important to be taken lightly. Schedule III of Companies Act, 2013 
came to his mind instantaneously in context of their talks pertaining to a 
manufacturing company. 
Performing audit procedures to verify such assertions provides evidence to auditor 
which is evaluated in light of overall circumstances. Such procedures are indeed 
bedrock which help auditor to crystallize his opinion in form of audit report. 
Wanting to learn comprehensively about such procedures particularly in context of 
companies, he scrolled mouse to next page. 
© The Institute of Chartered Accountants of India
a
 
 
AUDITING AND ETHICS  
 
5.4 
 INTRODUCTION  
Companies prepare their ?nancial statements in accordance with the framework of 
generally accepted accounting principles (Indian GAAP), also commonly 
referred to as accounting standards (AS). 
A ?nancial statement audit comprises the examination of an entity’s ?nancial 
statements and accompanying disclosures by an independent auditor. The result 
of this examination is a report by the auditor, attesting the truth and fairness of 
preparation and presentation of the ?nancial statements and related disclosures. 
The preparation and presentation of the financial statements is the responsibility 
of the management. 
Further, every financial statement contains an overall representation in addition to 
various specific assertions. Each financial statement purports to present something 
as a whole in addition to its component details. For example, an income statement 
purports to present “the results of operations” a balance sheet purports to present 
“financial position”. The auditor’s opinion is typically directed to these overall 
representations. But to formulate and offer an opinion on the overall truth of these 
statements he has first to inquire into the truth of many specific assertions that 
makes up each of these statements. Out of his individual judgements of these 
specific assertions he arrives at a judgement on the financial statement as a whole. 
In this chapter, we will be discussing in detail about the various audit procedures 
that an auditor can perform in order to verify the various assertions appearing in 
the financial statements. Before discussing about the audit procedures that an 
auditor can perform to verify the various assertions appearing in the financial 
statements, let us have a look at the meaning of the term assertion.  
DEFINITION OF ASSERTION: It refers to the representations by management, 
explicit or otherwise, that are embodied in the ?nancial statements, as used by the 
auditor to consider the di?erent types of potential misstatements that may occur. 
In preparing ?nancial statements, company’s management makes various implicit 
or explicit claims (i.e. assertions) regarding: 
• completeness; 
• cut-off; 
• existence/ occurrence; 
© The Institute of Chartered Accountants of India
Page 5


a
    
 
 
CHAPTER 
5 
 
 
LEARNING OUTCOMES 
  
 
 
 AUDIT OF ITEMS OF 
FINANCIAL 
STATEMENTS 
 
 
 
After studying this chapter, you would be able to understand- 
? The general considerations in an audit of financial 
statements. 
? The specific procedures for auditing heads of balance sheet 
and statement of profit or loss. 
? Audit procedures in respect of certain disclosures in the 
financial statements. 
? Practicality of above concepts using examples and case 
studies. 
 
© The Institute of Chartered Accountants of India
a
 
 
AUDITING AND ETHICS  
 
5.2 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Measurement 
INCOME STATEMENT CAPTIONS COMPRISING REVENUE AND EXPENSE BALANCES 
Occurrence 
Completeness 
Cut off 
Presentation & 
Disclosure 
BALANCE SHEET CAPTIONS COMPRISING ASSETS, LIABILITIES AND EQUITY 
BALANCES 
 
Existence 
Completeness 
Cut off Valuation 
Rights & 
Obligations 
Presentation 
& Disclosure 
CHAPTER OVERVIEW 
 
W
© The Institute of Chartered Accountants of India
 
 
AUDIT OF ITEMS OF FINANCIAL STATEMENTS
 
 5.3 
Full import of “Substantive audit procedures” was already ingrained by Sameer. 
However, he wanted to know how such procedures are actually applied. How such 
detailed checking is carried out by team carrying out audit? Are there separate 
yardsticks for verifying “transactions” and “balances”? And what is logic behind 
detailed checking of “transactions” and “balances”? Recalling the basic premise of 
preparation of financial statements by the management, it flowed to him logically 
that such preparation of financial statements ought to involve expressly stated or 
implied statements. While carrying out detailed checking, auditor basically tries to 
verify these assertions. 
Shekhar had told him that while verifying transactions and balances of the 
manufacturing company they were auditing, all assertions backing up these were 
verified. For example, while verifying sales of the company, it was verified that sales 
pertaining to the company have, in fact, taken place. It was also verified that data 
in respect of these transactions was recorded correctly. Nonetheless, it was made 
sure to verify recording of transactions in correct accounting period. And there 
were others too!  
Similarly, while verifying trade receivables, procedures were applied to confirm 
existence of these balances. It was also checked that money represented by trade 
receivables was, in fact, recoverable. Were some balances under litigation or under 
dispute? All such aspects were gone through to obtain assurance that the balances 
were properly valued. And how can disclosure requirements be left behind? 
Whether all disclosures have been made in respect of such balances which were 
required to be made in accordance with applicable financial reporting framework? 
Besides this, analytical procedures also needed to be performed to bring out 
variations and fluctuations. 
Gathering that transactions and balances reflected in financial statements convey 
so many things, both stated and understood, he found such a framework quite 
logical. In this context, requirements of applicable financial reporting framework 
become too important to be taken lightly. Schedule III of Companies Act, 2013 
came to his mind instantaneously in context of their talks pertaining to a 
manufacturing company. 
Performing audit procedures to verify such assertions provides evidence to auditor 
which is evaluated in light of overall circumstances. Such procedures are indeed 
bedrock which help auditor to crystallize his opinion in form of audit report. 
Wanting to learn comprehensively about such procedures particularly in context of 
companies, he scrolled mouse to next page. 
© The Institute of Chartered Accountants of India
a
 
 
AUDITING AND ETHICS  
 
5.4 
 INTRODUCTION  
Companies prepare their ?nancial statements in accordance with the framework of 
generally accepted accounting principles (Indian GAAP), also commonly 
referred to as accounting standards (AS). 
A ?nancial statement audit comprises the examination of an entity’s ?nancial 
statements and accompanying disclosures by an independent auditor. The result 
of this examination is a report by the auditor, attesting the truth and fairness of 
preparation and presentation of the ?nancial statements and related disclosures. 
The preparation and presentation of the financial statements is the responsibility 
of the management. 
Further, every financial statement contains an overall representation in addition to 
various specific assertions. Each financial statement purports to present something 
as a whole in addition to its component details. For example, an income statement 
purports to present “the results of operations” a balance sheet purports to present 
“financial position”. The auditor’s opinion is typically directed to these overall 
representations. But to formulate and offer an opinion on the overall truth of these 
statements he has first to inquire into the truth of many specific assertions that 
makes up each of these statements. Out of his individual judgements of these 
specific assertions he arrives at a judgement on the financial statement as a whole. 
In this chapter, we will be discussing in detail about the various audit procedures 
that an auditor can perform in order to verify the various assertions appearing in 
the financial statements. Before discussing about the audit procedures that an 
auditor can perform to verify the various assertions appearing in the financial 
statements, let us have a look at the meaning of the term assertion.  
DEFINITION OF ASSERTION: It refers to the representations by management, 
explicit or otherwise, that are embodied in the ?nancial statements, as used by the 
auditor to consider the di?erent types of potential misstatements that may occur. 
In preparing ?nancial statements, company’s management makes various implicit 
or explicit claims (i.e. assertions) regarding: 
• completeness; 
• cut-off; 
• existence/ occurrence; 
© The Institute of Chartered Accountants of India
 
 
AUDIT OF ITEMS OF FINANCIAL STATEMENTS
 
 5.5 
• valuation/ measurement; 
• rights and obligations; and 
• presentation and disclosure 
of Assets, Liabilities, Equity, Income, Expenses and Disclosures in accordance 
with the applicable accounting standards. 
Example 
If Company X’s balance sheet shows Building with carrying amount of ` 50 lakh, the 
auditor shall assume that the management has claimed/ asserted that:  
• The building recognized in the balance sheet exists as at the period- end 
 (existence assertion);  
• Company X owns and controls such building (Rights and obligations 
 assertion); 
• The building has been valued accurately in accordance with the measurement 
 principles (Valuation assertion); 
• All buildings owned and controlled by Company X are included within the 
 carrying amount of ` 50 lakh (Completeness assertion). 
The auditor then needs to draw an audit programme to verify the assertions made 
by the management by obtaining sufficient and appropriate audit evidence for each 
of the claims made on Account Balances, Class of Transactions and Related 
Disclosures. 
ASSERTIONS MAY BE BROADLY CLASSIFIED INTO THE FOLLOWING TYPES 
1. INCOME STATEMENT CAPTIONS COMPRISING  
REVENUE AND EXPENSE BALANCES 
Assertions Explanation Example: Employee bene?t 
expenses and sales 
Occurrence Transactions recognized in the 
?nancial statements have 
occurred and relate to the 
entity. 
(i)  Employee bene?t 
expense has been 
incurred during the 
period in respect of the 
© The Institute of Chartered Accountants of India