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AUDIT CYCLE FOR

INCOME STATEMENT

GROUP 9
Topics to Be Covered
• Definition of income statements
• Documents needed
• Audit cycle for income statement
• The Audit of Financial Statement Assertions
• Audit test and substantive test
• Summary
• Questions
Type of Document Function
Statement of Income It report the company’s revenues, expenses, gains and losses for a
period of time such as a year or semi annually.
Statement of Comprehensive Income This financial statement begins with the bottom line of the income
statement and then lists the items considered to be other
comprehensive income. Some of these items involve currency
translation, hedging, and pensions.
Balance Sheet This report shows the financial position of a business as of the
report date. The information is aggregated into the general
classifications of assets, liabilities, and equity. This is a key
document, and so is included in most issuance of the financial
statements.
Statement of Cash Flow This report reveals the cash inflows and outflows experienced by an
organization during the reporting period. These cash flows are
broken down into three classifications, which are operating
activities, investing activities, and financing activities.
Statement of Changes in Equity This financial statement is often presented as the statement of
shareholders' equity, statement of equity and statement of changes
in stockholders' equity. It reports all of the changes in
stockholders' equity which occurred during the accounting period.
AUDIT PROCEDURE FOR INCOME
STATEMENT

AUDIT OF REVENUE
EXPENSES AUDIT

COST OF INTEREST
GOODS EXPENSE
SOLD
AUDIT

OPERATING
EXPENSES
AUDIT OF EXPENSES
Determine the amount of inventory sold
COST OF
GOODS SOLD Determine the cost of the inventory sold on a unit basis

Auditors will randomly choose expense transactions and ask for


supporting documentation for the expenditure

OPERATING Transactions that are related to other accounts, the auditor


EXPENSES may complete an analytic test

Additional procedures are performed to determine why the


account balance differs from the expectation

Obtain the original loan documentation or promissory note


INTEREST
EXPENSE
Recalculate the amount of interest expense owed
REVENUE AUDIT

Review the company's revenue recognition policies and


ensure that revenue is only recorded when appropriate
OVERSTATEMENT
Select transactions to ensure that it was appropriate to
record a sale

Make selections from reciprocal balances


UNDERSTATEMENT
For revenue, the auditor may examine accounts
receivable
Audit Financial Statement assertions
Assertions can be classified into the following types

Assertions relating to classes of transactions

Assertions relating to assets, liabilities and equity


balances at the period end

Assertions relating to presentation and


disclosures
Transactions Assertion
Assertion Relevant test
Occurance Select sample of entries from the sales account in the nominal ledger
and trace to the appropriate sales invoices and supporting goods
dispatched notes and customer orders
Completeness Select a sample of customer orders and check to dispatched notes
and sales invoice and the posting to the sales account in the nominal
ledger
Accuracy Calculation checks on invoices, payroll and the review of control
account reconciliations are designed to provide assurance about
accuracy
Cut-off Recording last goods received notes and dispatched notes at the
inventory count and tracing to purchase and sales invoices to ensure
that goods received before the year-end are recorded in purchases at
the year end and that goods dispatched are recorded in sales
Classification Check purchase invoices posting to nominal ledger accounts
Authorization/present Check the total employee benefits expense in analysed in the notes to
ation the financial statement under separate headings such as wages and
payroll, pension costs, social security contributions and taxes.
Account Balance Assertion
Assertion Relevant test
Existence Physical verification of non-current assets, circulations of receivables,
payable and the bank letter
Right & Obligations In the case of property, deeds of title can be checked. Current assets are
often checked to purchase invoices although these are primarily used to
confirm cost. Long term liabilities such as loans can be checked to the
relevant loan agreement
Completeness A review of the repairs and expenditure account can sometimes identify
items that should have been capitalized and have been omitted from non-
current assets. Reconciliation of payable ledger balances to suppliers’
statement is primarily designed to confirmed completeness although it also
gives assurances about existence
Accuracy, valuation Vouching the cost of assets to purchase invoices and checking
and allocation depreciation rates and calculations
Classification The test for transaction of checking purchase invoice postings to the
appropriate accounts in the nominal ledger will be relevant again.
Authorization/presentat Auditors often use disclosure checklist to ensure that financial statement
ion presentation complies with accounting standards and relevant legislation
Substantive Test for Income Statement
Example
1. Writing to customers asking Definition
them to confirm the amount -Tracing figure to supporting
owed (existence and ownership). documentation to determine if
2. Observation/inspection of transaction are valid, properly
amounts received after year end. classified, accured and complete.
This gives evidence about Test also include recalculating
valuation because if a payment is and confirming recorded
received subsequently the debt information.
was obviously not bad.

Test of
detail
Substantive Test for Income Statement
Example
-Compare income
statement information
with prior period
information, budget,
forecast, data from
Procedures similar program or Definition
1. Understand the agency and organizational unit -Consist of the
obtain information necessary to
plan the nature, timing and extend comparison of data
of audit procedure from different sources to
2. Obtain the evidence related to determine if reported
account balances and classes of
transaction
information looks odd or
3. Final review of financial wrong.
information tested

Analytical
test
Example of analytical test for income
statement

Ratio Actual Budget Prior year Industry


Current ratio 1.4 1.3 1.3 1.5
Account 6.0 7.6 7.4 8.1
receivable
turnover
(sales/
Gross margin 7.7 9.0 9.6 9.0
(%)
Allowance 1,280 1,300 1,600 1,430
for bad debt
('000)
Example of analytical test for income
statement
a) List three ratio/account balances that are the greater risk of
mistatement and would therefore require more detailed
investigation and testing by the auditor

Answer :
The two ratio that are at the greater risk of mistatement are
account receivable turnover, gross margin and allowance for
doubtful debt
Example of analytical test for income
statement
• Account receivable decrease from 7.4 to 6.0. This shows that the
company are slow at collecting money. This indicates that
something may going on there. Therefore this part require
auditor to do more detailed investigation.
• The company slow collecting money may be caused by
collection problem by its customer
• The company may re-evaluate the credit policies to ensure
timely receivable collection from its customer to solve this
problem.
Example of analytical test for income
statement

• Gross margin show significant drop of 9.6% to 7.7%. Supposed


that, sales and COGS should be moving in the same ratio at the
same percentange. This situation may indicate to mistatement,
therefore, it is definately something that the auditor should
investigate to.
Example of analytical test for income
statement

• Allowance for doubtful debt is contra with account receivable


turnover. Therefore, when account receivable turnover ratio
decrease the allowance for doubtful debt should increase but
from the table we can see that it is also decrease. The auditor
are required to do detail investigation.
Example of analytical test for income
statement

b). State the account and applicable assertion at risk based on


the ratios stated in part a). Provide reasons for your answer.
Account receivable turnover ratio
- The account that would be relate is provision for doubtful debt
because of the concern of the customer not paying. The assertion
is existence. In existence the auditor should make sure that all the
account receivable recorded are actually exist.