You have found that land and buildings have been revalued during the year. What work will you perform to verify the revaluation?

The specific work involve will include:

Assess professional competence of the valuers. This will involve (a)considering the professional certification or licensing by, or membership in, an approved professional body and (b) experience and reputation in the field of valuers

Assess objectivity and independence of the valuers.

Assess appropriateness of the valuer’s work as audit evidence for revaluation of the land building. This will involve consideration of:
a) source data used
b) assumptions used
c) testing data used by the values
Consider that valuer is experienced in valuing properties like those which have been restated at revaluation by the client and the same geographical area.
Discuss with the valuer the basis used to value the property. Review documents in possession of the valuers for source and reliability. Inquire the values of current market pnces for similar and other property.
Ascertain rental value of similar property to estimate current value of
client’s property. Check local or national statistics available for indices of properties.

How would you verify adequacy of accumulated depreciation?

1. Assess reasonableness oflives of high value assets
2. Assess reasonableness of depreciation method used in relation to pattern in which the asset’s future economic benefits are expected to be consumed by the client
3. Review estimate of residual value
4. Ensure that depreciation is recognized even if the fair value of asset exceeds its carrying amount
5. In case of revaluation, depreciation should be charged on revalued amount
6. Leased assets should be depreciated over lease term, unless there is a reasonable expectation that the assets will be transferred to lessee, in which case, the leased assets may be depreciated over their useful lives.
7. Excessive losses on disposal may indicate that depreciation was inadequate.
8. Fixed assets register
9. Re computation

When the auditor verifies fixed assets, he should perform two way test i.e., test some items from accounting records to physical and some items form physical to accounting records.
Explain the assertions to be verified and possible audit adjustment case of discrepancies

The objective of checking accounting records to physical is to ven; existence assertion. If there are differences the matter should investigated. The write off should be authorized. The objective of checking physical to account records is to verify that assets acquired are recorded.

How would you verify existence assertion of investments?

Evidence that may be inspected for existence assertion of investments include:
1. Physical inspection
2. Bank confirmation for investments held as mortgage or safe custody
3. Receipt of dividend

List some control fixed relating to fixed assets

1. Non existent fixed assets included in balance sheet
2. Fixed assets may exist but not included in balance sheet
3. Unauthorized purchased and disposals
4. Proceeds form disposals misappropriated
5. Fixed assets may not be owned by the entity.
6. Fixed assets mortgaged against loans not disallowed
7 Capital and revenue expenditure incorrectly classified
8 Inconsistent depreciation policy
9 Inadequate depreciation

How would you verify adequacy’ of depreciation charge for fixed assets?

1 Inspect the property to ascertain reasonableness of the remaining useful life

2. Compare depreciation charged witr the budget.

3. Consider assumptions on which management has established
depreciation rates

4. Verify that the rates have been “)p~opnately approved.

5. Depreciation rates used by otl e companies in the same industry.

What procedures will you apply to verify possible understatement of fixed assets?

Significant procedures to detect understatement of non-current assets will include:
1. On a test basis select some equipment items and trace to fixed assets register. Investigate items pbysically found but not entered in fixed assets register.
2. Review records of income yielding assets. Ascertain relationship of income with value of assets.
3. Compare fixed assets register with general ledger. Inquire reasons for not including in general ledger cost of certain assets, if any, appearing in fixed assets register.
4. Check whether any capital expenditure has been charged to revenue.
5. Verify that finance leases have not been treated as operating leases.

What matters would you consider in verifying intangible assets?

(i) An intangible asset should be recognized if, and only if:
(ii) An enterprises should assess the probability of future econom, benefits using reasonable and supportable assumptions represent management’s best estimate of the set of economic conditions that will exist over the useful life of the asset.
(iii) If an intangible asset is acquired separately , the cost of the intangible asset can usually be measured reliably. This is particularly so when the purchase consideration is in the form of cash or other monetary assets.
(iv) The cost of an intangible asset comprises its purchase price, including any import duties and non-refundable purchase taxes, and any directly attributable expenditure on preparing the asset of its intended use. Directly attributable expenditure includes, for example, professional fees for legal services. Any trade discounts and rebates are deducted in arriving at the cost.
(v) If payment for an intangible asset is deferred beyond normal credit terms, its cost is the cash price equivalent; the differences between this amount and the total payments is recognised as interest expense over the period of credit unless it is capitalized under the allowed alternative treatment in IAS 23, Borrowing Costs.
(vi) If an intangible asset is acquired in exchange for equity instruments of the reporting enterprise, the cost of the asset is the fair value of the equity instruments issued, which is equal to the fair value of the asset.
(vii) Under IAS 22 (revised 1998 ) , Business Combinations, if an intangible asset is acquired in a business combination that is an acquisition, the cost of that intangible asset is based on its fair value at the date of acquisition.

How would you verify development expenditure?

1. Obtain or prepare a lead schedule of development expenditure, check opening balances and verify the total per lead schedule with the general ledger and balance sheet.
2. Verify the costs incurred with supporting documents
3. Review expected further costs of the project
4. Review estimates of the revenues to be generated from use of the asset
5. Review estimated useful life
6. Review capitalization criteria as set out in IAS 38, Intangible assets
• Technical feasibility of completing intangible asset
• Entity’s intention to complete the intangible asset
• Entity’s ability to sell or use the intangible asset
• Whether: intangible asset is likely to generate future economic benefits
• Availability of technical and financial resources
• Ability to measure the expenditure attributable to the intangible asset during development.

7. Verify that development costs are de recognized when no future economic benefits are expected from its use or disposal.

8. Review entity’s projected financial statements to assess that amount deferred along with estimated further costs do not exceed projected revenues

9. Assess reliability of projections

10. The gain or loss arising from de recognition of deferred costs is the difference between the net sale proceeds, if any, and the carrying value. The gain or loss should be transferred to income statement

11. Following disclosure should be made

•  Amortization method used
• Gross carrying amount and accumulated amortization
• A reconciliation of carrying amount at the beginning and end of the
accounting period, showing:

(i) Additions
(ii) Impairment
(iii) Amortization during period
• Development expenditure recognized as expense during the period

List three risks and three evidential matters in verifying development cost


1. Development cost has significant inherent risk due to nature of account and judgments involved.
2. Consider commercial viability. Be alert that the product may not generate future economic benefit if future revenues will not cover costs.
3. Bank may withdraw funding if certain

Evidential matter:

1. Verify that the licence to develop the product is granted by appropriate authorities.

2. Compare actual cost to date with budgeted cost..

3. Review adequacy of amortization by comparing actual sales after commercial production with budgeted sales.


While verifying valuation assertion of inventories in Sameer Manufacturing company, you have noted that following costs have been fully charged to inventories.

(a) Selling expenses
(b) General and administration expenses
(c) Interest paid
(d) Under recovery of overheads

Set out your comments on above

Selling expenses

Selling expenses are not considered to be directly related to acquisition or production of goods. These are more directly related cost of goods sold rather than unsold goods. Selling expen es are, therefore. not considered as part of inventory costs.

General and administrative expenses

General and administrative expenses are usually excluded from cost of inventories because such expenses are so unrelated or indirectly related to the immediate production process that any allocation is purely arbitrary. However, where some administrative costs can be allocated as production overheads on a systematic basis, for example, rent of building or wages of the accounting staff dealing with affairs of production may be included in cost of inventories.

Interest costs

Interest costs associated with getting inventories ready for sale are
charged to expenses as incurred. IAS 23, Borrowing Costs, only allows capitalization of those borrowing costs which are directly attributable to the acquisition, construction or production of a qualifying asset. Inventories that are routinely manufactured or otherwise produced in large quantities on a repetitive basis over a short period of time are not considered as qualifying assets

Under recovery of overheads

Under recovery of overheads is not allocated to products. This is recorded as expense of the current accounting period.

IAS 2 states that allocation of fixed production overheads to the cost of conversion is based on the normal capacity of production.

Explain what you understand by normal capacity

Normal capacity is the production expected to be achieved on an average over a number of periods (often five years) under normal circumstances, taking into account the loss of capacity resulting from planned maintenance, seasonal, cyclical and trend factors. The amount of fixed overheads allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are treated as period costs. In period of abnormally bigh production, the amount of fixed overheads allocated to each unit of production is decreased so that inventories are not measured above cost


Inventory counted on December 31 20x? was 25 units

Selling expenses are estimated to be 10% of sales.


Compute the value of inventory to be reported in financial statements for 20x?


G Mart Super Stores has adopted following procedure for valuation of year-end inventory. Records of cost retail value of the goods available for sale are maintained. The cost to retail percentage is applied to closing inventory at retail price to determine inventory at cost.

The accounting records reflect:


Your comments on the acceptability of the inventory valuation method of G Mart

Generally the super market inventory consists of thousands of different type of merchandise at low unit costs. The application of unit cost to inventory quantities is too cumbersome and time consuming. In most super markets, a relationship between cost and sale price may be determined. Use of such relationship to estimate inventory cost is quite legitimate. Inventory on hand can be valued at the selling prices marked on merchandise. The cost to retail ratio is applied to the goods on hand at selling price to determine cost of closing inventory. The percentage used takes into consideration inventory, which has been marked down to below its original price. .
This method, commonly known as retail method is allowed by IAS-2 in retail industry for measuring of large number of rapidly changing items that have similar margins and for which it is impracticable to use other costing methods.
A serious limitation of this method is that it is based on average mix. It may result in incorrect inventory valuation if mix of the closing inventory is not the same as the mix of goods available for sale, assume that the cost to retail ratio of 80% consists of equal proportion of inventory items that have cost to retail ratio of 75%, 80%, and 85%, respectively. If the closing inventory contains. only items with 75% ratio, the value of closing inventory will be incorrect. This problem can be minimized by applying the retail method on product – line or departmental basis.

Discuss auditor’s duties as regards observation of physical inventory, before, during, and after the count

Before physical Inventory

1. Evaluate client’s planning of physical inventory. The evaluation of client’s planning will require consideration of following matters.
a) Designating by client’s management of an individual employee, preferably a representative of finance department, to assume responsibility for the physical inventory

During physical Inventory

It is not auditor’s function to take inventory or to control or supervise the stock taking; this is the responsibility of management. The auditor’s responsibility is to observe the inventory taking, However, to observe the inventory taking implies a much more active role, than that of a mere spectator. In this regard auditor’s duties are:

1. Determining that all usable inventory owned by the client is included in the count.
2. Inventory taking instructions are complied.
3. Be alert of inclusion of any obsolete or damaged inventory.
4. Record serial number of the final receiving and delivery documents issued before taking of inventory so that accuracy of the count cut off can be determined at a later date.
5. Closely observe delivery and or receipt of goods taking place during the counting process and any reconciliation made.
6. Observe that the client is controlling the inventory sheets or tags properly.
7. Test count selected inventory items, both from physical to coun: sheets and from count sheets to physical
8. For test count of work in process, the auditor must ascertain percentage or stage of completion indicated on inventory tag if appropriate.
9. Ascertain that numerical control is maintained over both inventory
tage and inventory sheets.
10. Make inquires to ascertain whether any of the materials or goods on hand are the property of others, such as goods held on consignment or customer – owned materials sent in for machine work or other processing.
11. Prepare working papers indicating:
i) Extent of test counts
ii) Deficiencies noted
iii) Conclusion as to whether the physical inventory appeared to have been properly taken in accordance with client’s instructions.

After physical inventory

1. Obtain a copy of completed physical inventory.
2. Test extensions and footing of the final inventory listing

Here the auditor should be alert of:

i) Misplaced decimal points, for example an inventory listing that extends 1,000 units times per Re. 1 per hundred as Rs. 1,000, will be overstated by Rs. 990
ii) Incorrect extension of count units with price per unit.

3. Trace to the completed physical inventory, the test counts performed earlier.
4. Determine that all inventory items are included in the final stock
5. Check cut off with reference to last document number noted at
physical count

Enumerate any 4 cut off procedures that you would apply relating to inventories of December 31, 20×3 The relevant data is:


1. Select GRN# 100 to 117 and check that all related invoices have
been entered in the purchase day book in the year ended December 31, 2003. If invoices have not been received ensure that an accrual has been made. The objective is to ensure that invoices relating to goods received prior to year end have also been entered in purchases.

2. Select suppliers invoice # 646 to 656 and match with GRN. If any
Invoice bears GRN # prior to GRN 117 ensure that related goods have been entered in purchases book of year end ended December 31, 20×3 (provided risks and rewards have been transferred)

3. Select Delivery notes numbers 930 to 945 and ensure that related goods have been entered in sales day book. Otherwise sales and debtors will be understated.

4. Select delivery note numbers 946 to 956 issued in the first week o: 20×4 to ensure that none of these bears sales invoice prior to # 345 to avoid double counting in both inventories and Receivables.

List down some audit procedures for verification of stock held
controlled by a third party.

The auditor would obtain direct confirmation from third party as to the quantities and condition of inventory held on behalf of the entity.
Depending on the materiality of this inventory the audit will also consider:
(a) integrity and independence of third party
(b) observing or arranging to observe physical inventory count
(c) obtaining another auditor’s report on the adequacy of third party’s internal control for ensuring that inventory is correctly counted and adequately safeguarded
(d) inspecting documentation regarding inventory held by third parties

How would you verify allowance for slow moving and obsolete

1. Inquire of management procedures for identifying slow moving and obsolete inventories
2. Carry out analytical procedures. An unusual increase in number of days inventories may indicate inadequate allowance for slow moving and obsolete inventories. Consider following example. You are the auditor for year ended December 31, 20×9. You have carried out inventory turnover analysis from the following data. (Rs. in millions) Year 20×9 reflects significant increase in number of days. If the company policy is still to maintain inventories for two months, the allowance may be understated.
3. Obtain or prepare an age analysis of inventories
4. At the time of observation of physical count, note rusty, dusty, damaged, spoiled and broken inventories.


You are the auditor of an entity engaged in the trading of furniture. The entity has two warehouses and employs about 200 employees. The management has requested you to assist in preparing year-end inventory count instructions. Develop inventory count instructions which would require directors’ approval before these are issued by management to count teams

Inventory count instructions
1. The inventory count will start at 9 AM sharp on Jan 1, 2009.
2. We have two warehouses. Warehouse A and B.
3. There will be a pair of two count teams.
4. Mr. Pixie (from stores who is familiar with items) and Mr. DiXIe from accounts will count inventories in warehouse A.
5. Mr. Rick (from stores who is familiar with items) and Mr. Shaw from accounts will count inventories in warehouse B.
6. The count will be supervised by Mr. Wood.
7. Before inventory count:
(a) Last GR number, last supplier’s invoice number, last ere note number, last sales invoice number and last dispatch note number will be noted.
(b) Like items will be placed at one place
(c) Pre numbered count sheets will be given to the count team
(d) Defective, spoiled and slow moving items will be physical segregated
(e) Goods sold but not delivered will be identified
(t) Goods held for others will be separated

8. During the count no transfers will be made between the two warehouses.

9. During the count no goods will be dispatched except for emergency purposes details of which will be recorded.

10. Goods received during count will be physically separated.

11. In warehouse A, Mr. Pixie will count the items and Mr. Dixie will enter the quantity on stock sheets. He will then place a red sticker on the bin or shelves, indicating that the item has been counted.

12. In warehouse B, Mr. -Rick will count the items and Mr. Shaw will
enter the quantity on stock sheets. He will then place a red sticker on the bin or shelves, indicating that the item has been counted.

13. Once the count is complete, Mr. Pixie and Dixie will visitwarehouse B and Mr. Rick and Shaw will visit warehouse A and
start recounting.

14. The count teams will take out red sticker and place blue stickers indicating that the item has been double counted.

Why should an entity count inventories at year-end when perpetual inventory records are available?

Even if perpetual inventory records are available, inventory count is
required in order to:
• Confirm accuracy of perpetual records
• Identification of damaged, defective and spoiled goods

When the auditor attends year end inventory count, he should perform two way test, i.e., test some items from count sheets to physical and courte items form physical to count sheets.

Explain the assertions to be verified and possible audit adjustments in case of discrepancies

The objective of checking count sheets to physical is to verify existence assertions. If there are differences the matter should be investigated and in case of shortage, inventories should be taken on the basis of physical count.

The objective of checking physical to count sheet is to verify completeness assertion. On possibility could be that related goods have been included in sales of current period in order to inflate the revenue. Such goods should have been included in inventories and excluded form sales and receivables at year end

Your client carries out inventory count on a continuous basis. What: matters would you consider to verify the reliability of such count.

Following matters need be considered:

review the client’s records of inventory count including basis selection ascertain action taken on differences between book inventory physical inventory ensure that all significant inventory items are counted at least once a year
examine count sheet to ensure that slow moving an ob 0 inventories are identified at the time of inventory count.

List down steps to verify Net realizable value

1. Obtain age analysis of inventories and identify slow items.
2. Obtain selling prices to verify unit selling price
3. Review reasonableness of further cost to incur and direct selling expenses.
4. Verify subsequent selling prices
5. Review reports of stock takers for damaged and defective items
6. Review quantities moved in subsequent period.

Some of the auditor procedures to be performed ill the context of physical inventory court are:
1. Review prior year working papers
2. Review internal control weaknesses
3. Consider reliance on the work of internal auditor
4. Review client’s count instruction
5. Verify that count sheets are pre numbered
6. Obtain third party confirmation
7. Consider specialized nature of inventories
8. On a test basis compare quantities per count sheet with physical
9. On a test basis compare physical with count sheets
10. Make notes of damaged, rusty dusty, defective items
11. Note goods held for third parties
State briefly the objectives of each of the above audit procedures.

1. A review of prior year working papers will help the auditor to familiarize with the nature, approximate volume, location, countprocedures, and problems experienced. If the controls are weak, (for example” inadequate security and access to inventory, inadequate inventory records) a larger sample size will have to be selected for physical count. Similarly, it will be preferable to count inventory at year end rather than before or after year end.

3. If reliance can be placed on the work of internal auditor, the external auditor may request internal auditor to attend physical count on some of the locations.
4. Improvement may be suggested in count instruction and as a result the year end inventory will be more accurate
5. Pre numbering would be useful to verify completeness assertion
6. To obtain evidence as regards existence of inventories with third parties
7. Assistance of expert may be considered
8. Verification of counts sheets to physical will provided evidence of existence
9. Verification of physical to count sheets will provide evidence for completeness
10. Notes on rusty, dusty and damaged inventory will be useful to ascertain NRV
Goods held for third parties, for example, on consignment, should be excluded form inventories.

Discuss key issues in the verification of year end inventories.

Key issues in verification of inventories are:

1. Existence

Inventories are susceptible to theft and pilferage. The audi should review inventory count instructions, observe inven – count, perform test counts and note down condition of inventor,

2. Valuation

Particular attention is required in evaluating adequacy provision for slow moving and obsolete inventories

3. Cutoff

Goods received notes and dispatch notes issued a few before and after year end should be matched with purchas

sales invoices to verify that transactions have been recorded in the correct accounting period

How would you verify net realizable value of inventory in a
manufacturing company.

1. Verify subsequent sales, in order to ascertain actual selling price.
2. Verify subsequent payments for further costs incurred, in orderto verify that estimated costs agree with subsequent costs.
3. Consider whether any direct selling expenses are necessary to sell the product. The purpose is to check that direct selling costs, for example commission to salesmen have been considered in ascertaining NRV

Your firm is the auditor of Shahzad Limited (SL), a listed company, which is a wholesaler of consumable products. SL records its sale on delivery of goods and maintains up to date computerized inventory records.
A full inventory count was conducted at the year end. The senior who attended the physical stocktaking at the central warehouse has observed the following matters:
(i) The inventory count took place on January 1, 2010 under the
supervision of the Inventory Controller. No movement of inventory took place on that day.

(ii) Four counting teams were formed. Each team comprised of two persons. The floor area was allocated by the teams among themselves. 

(iii) Each team was instructed by the Inventory Controller to remember which inventory had been counted.

(iv) Pre-numbered count sheets were provided to the staff involved in the inventory count. The count sheets showed the inventory ledger balances, to facilitate reconciliation.

(v) Old, Slow-moving or already sold inventories were highlighted on the count sheets at the time of counting.

(vi) . Items not located on the pre-numbered inventory sheets were recorded on separate sheets which were numbered by the staff.
(vii) At the end of the count, all inventories against which advances from customers had been received were removed from the physical inventory on the instruction of the Inventory Controller. 


Identify the weaknesses. in the system of inventory count. Give
appropriate explanations to support your point of view.

Following weaknesses In inventory count are identified from audit senior’s observations:

(i) Lack of segregation of duties

The Inventory Controller is responsible for the physical control of the inventory and is also supervising the stock count.

(ii) Non availability of detailed plan

Allocation of counting area by the teams themselves indicate non availability of detailed plan which may lead to certain inventory items being counted more than once while some items may not be counted at all.

(iii) No system of marking on counted items

This again may lead to double counting or omission completely.

(iv) Perpetual inventory records available on count sheets

The person responsible for counting may try to match the numbers provided instead of carrying out an independent count.

(v) Additional count sheets are not pre-numbered

If the separate sheets are numbered as they are used, there is no means of identifying that all sheets issued have been returned and the last count sheet(s) may go unnoticed

Set out five possible weaknesses in the system of inventory count.

1. Inventory count instructions are not in writing
2. Count sheets issued to stock takers include quantity per records
3. Count team members are from warehouse only
4. Items counted are not marked
5. Purchases and sales are not stopped during stock count.

What matters would you consider in selecting accounts for confirmation of receivables?

Matters to be considered in selecting accounts for confirmation include:

• Customers with credit balances
• Large customers over a certain amount.
• Custsmers .with balances in excess of credit limits .
• Customers who have paid later invoices but have not settled earlier invoices.
• Long outstanding balances
• Customers who do not pay against specific invoices but make payments on account in round sums.
• Stratification

Enumerate significant points to verify allowance for doubtful accounts.

1. Obtain age analysis.
2. Check additions of age analysis.
3. Review accuracy of the aging of balances particularly when payments are made on account.
4. Assess reasonableness of the formula applied for estimating allowance.
5. On a test basis, trace balances from accounts receivable ledger to age analysis.
6. Perform analytical procedures. Compare number of days’ sales this year with last year.
7. Check subsequent collections.
8. Check approval for allowances and write off.
9. Verify specific provisions considering correspondence with debtors.
10. Review responses from customers for direct confirmation.
11. Review directors’ minutes for major write off
12. Inquire about disputed invoices
13. Investigate customer balances over the credit limit.
14. Study correspondence with customers considered doubtful.
15. Consider if any legal proceeding have been instituted against some customers.


What alternative procedures can be applied if some of the receivables cannot be directly confirmed

If the receivables cannot be confirmed, alternative procedures may be
• Review of subsequent collections
• Inspection of invoices and delivery notes
• Analytical procedures on the aging schedule of receivables

List four significant procedures to verify accrued expenses

1. Obtain or prepare a schedule of accruals
2. Check subsequent payments
3. Compare with last year and investigate unusual items or accruals which were make last year but are not reflected in current years schedule.
4. Carry out analytical procedures where relationship is expected to

Discuss three types of positive confirmation

Positive confirmation may be in the following form.
1. Confirmation of single transactions rather than of entire account balance.

Customers may not always be able to confirm entire amount balance, but may be able to confirm individual invoice amount with total balance:

2. Request the customer to reply to the auditor in all cases indicating the customer’s agreement with the given information. There is risk that the customer may reply to the confirmation request without verifying that the information is correct. The auditor has no way to ascertain whether this has occurred.

3. Request the customer to fill in the information

The risk that the customer replies without verification is reduced if customer is required to fill in the amount due. However the use of this type of confirmation may reduce response rate.

You are the Manager on the audit of Ghazi Power Limited (GPL), a gas transmission and distribution company, for the year ending 31 October 2011. On the company’s request, your firm has agreed to complete the audit by 20 November 2011.
In order to meet the audit deadline, you are considering various measures which include sending requests for negative confirmations related to balances due on 31 August 2011. On 31 August 2011, total debtors aggregated Rs. 45 million. 50% of the amount is due from 15 major debtors, whereas the total number of debtors is 2,450.Moreover, GPL’s management is not allowing you to send a request for  confirmation of balance to SSO Ltd., which is among one of the 15 major debtors, because of certain ongoing legal disputes. Your previous experience with the client and the results of initial risk assessment procedures suggest that the risk of material misstatement is low.


(a) Discuss whether it would be appropriate to use the negative
confirmations procedure in the above situation.
(b) What audit procedures should be performed at the year end, if requests for confirmation of balances are sent on 31 August 2011?
(c) List the procedures that should be adopted due to management’s refusal to send a request for conformation of balance to SSO Ltd.
(a) Certain conditions are required to be met before an auditor can decide to use negative conformation as a sole substantive procedure, these conditions include:

(i) The auditor has assessed the risk of material misstatement as low and has obtained sufficient appropriate audit evidence regarding the operating effectiveness of controls relevant to the assertions;
(ii) The population of items subject to negative confirmationprocedure comprises a large number of small, homogeneous account balances transactions or conditions;

(iii) A very low exception rate is expected;

(iv) The auditor is not aware of circumstances or conditions that would cause recipients of negative confirmation requests to disregard such requests. In the given situation, condition # (i) and (ii), are met; the fact that risk of material misstatement is low suggests that condition # (iii) is also being met. Therefore it would be appropriate to use negative conformation provided that the fourth condition is met. For 15 major debtors, it would be appropriate to use positive confirmation as their population consists of small number of large balances.
(b) Audit Procedures:
(i) Prepare or obtain a client roll forward schedule from 31 August 2011, to 31 October 2011.
(ii) Agree individual entries for 31 October 2011, with the sales ledger and debtors control accounts.

(iii) Note and obtain explanation for any unusual journal adjustments.

(iv) Vouch material sales or receipts with supporting documents.
(v) Select a sample of receipts and sales and perform tests of controls to ensure that system of internal controls continued to operate effectively.

(vi) Re-perform cutoff test at year end.

(vii) Perform analytical procedures by comparing the balances of debtors on 31 August 2011, to Debtors on 31 October 2011, and ascertain reasons for major variances, if any.

viii) Check subsequent recovery of year end balances.

(c) If management refuses to allow the auditor to send a conformation request, the auditor shall:
(i) Inquire as to management’s reason for the refusal, and seek audit evidence as to their validity and reasonableness;
(ii) Evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of material misstatement, including the risk of fraud, and on the nature,
timing and extent of other audit procedures;
(iii) Perform alternative audit procedures designed to obtain relevant
and reliable audit evidence.
(iv) If the auditor concludes that:
• Management’s refusal to allow the auditor to send a confirmation request is unreasonable;
• The auditor is unable to obtain relevant and reliable audit evidence from alternative audit procedures the auditor shallcommunicate with those charged with governance and the  auditor shall also determine the implications of the results of procedures carried out above on the audit and the auditor’s opinion.

Direct confirmations of balances due from customers are obtained to satisfy the objective of ensuring that the customer exists and owes the specified amount to the company at a certain date.


(a) State the circumstances in which an auditor may decide notto circulate the requests for direct confmnation.
(b) What are the factors that an auditor considers while designing the requests for direct confirmation?
(c) Describe the alternative audit procedures which may be conducted if the customer does not reply to a request for confirmation.

(a) The auditor may consider not to circulate the direct confirmation to the customers where:
(i) Accounts receivables are immaterial to the financial statements; or
(ii) The response rate is not expected to be adequate;
(iii) The responses are not expected to be reliable;
(iv) Inherent and control risk in aggregate are assessed at low level.
(v) Audit evidence expected to be gathered through other substantive procedures (e.g. analytical procedures) is sufficient to reduce the audit risk to an acceptable level.

(vi) Management requests not to send the confirmation and auditor after satisfying himself from the reason and explanation given by the management.
(b) While designing the confirmation request, the auditor considers the following factors:
(i) Assertions being addressed through the direct confirmation.
(ii) Form of the external confirmation requests (i.e. positive or negative or combination of both)
(iii) Prior experience on the audit of similar engagements.
(iv) The nature of the information being confirmed.
(v) The intended respondent.
(vi) Type of information respondents will be able to confirm readily.
(c) The auditor may perform one or more of the following steps:
(i) Check receipt from customers after balance sheet date.
(ii) When there is no receipt from customers after balance
sheet date, the auditor should consider the following audit procedures:
Verify validity of purchase orders, if any.
Verify goods dispatched note other documents duly acknowledged by the customers.

(iii) Obtain explanations for invoices remaining unpaid, if any, after subsequent one have been paid.
(iv) Examine sales near the period end to provide audit evidence about cutoff assertion.

What steps would you take to verify bank reconciliation?

Steps to verify bank reconciliation include:

Obtain bank reconciliation.

2 Check balances per cash book and bank statement
3 Check arithmetical accuracy.
4 Check subsequent clearance
5 Check reconciling items of the last month which were not cleared during current month, appear on reconciliation.

You are a part of the team on the audit of Fresh Meat (Private) Limited which sells fresh meat products through 25 retail outlets. Each outlet holds cash at the year end. Sales are made on cash as well as against credit cards. All the accounting records are maintained at the outlets and balances with the Head Office are reconciled on a monthly basis.


List of audit assertions relevant to the audit of cash in hand and state how you would obtain audit evidence to support those assertions.

a) Audit Assertions
The key audit objectives in the audit of cash are to verify the assertions of:
(i) Existence
(iii) Completeness

What matters the auditor should verify if the company has issued shares at a premium
A company may issue shares to the public on premium subject to the

following conditions, namely:

(a) it shall have profitable operational record of at least one year;
(ii) the premium on public offering shall not exceed the amount of premium charged on placements with foreign or local institutions and the names and addresses of such institutions shall be disclosed in the prospectus;

(iii) the issue shall be fully underwritten and the underwriters, not being the associated companies, shall include at least two financial institutions, including commercial banks and the underwriters shall give full justification of the amount of premium in their independent due diligence reports;
(iv) the due diligence report of the underwriters shall form part of the
material contracts;
(v) full justification for premium shall be disclosed in the prospectus;
(vi) the employees of the company getting preferential allocation, if any, shall be charged premium at the same rate as the public; and
(vii) the shares allotted to any person on account of preferential allocation, at par, shall not be salable for a period of two years from the date of public subscription. These person shall be -issued jumbo certificates with markings “not salable for two years”. The particulars of each jumbo certificate will be furnished to the respective stock exchange. Companies while splitting jumbo certificates into marketable lots, after the prescribed period, shall inform the respective stock exchange

Your client has obtained a bank loan. You are concerned that the client may have falsified the accounts to meet certain debt covenants regarding current ratio and profitability.
Discuss procedures you would apply to dispel the doubt about such falsification.

I: The auditor should in particular verify:

• Allowance for bad debts
•  Allowance for obsolete and slow moving inventories
•  Depreciation
•  Deferred tax
•  Provision for a loss from a law suit
•  Provision for warranty claims

2. Review and test the process used by management to develop the
above estimates
3. Use independent estimate for comparison with that prepared b. management
4. Review subsequent events which provide evidence of reasonableness of estimate made
5. Evaluate data and assumptions on which estimates are based
6. Test calculations
7. Compare prior period estimates with actual
8. When there is difference between auditor’s estimates based audit evidence and the estimated amount in the statements, the management should be requested to revi e estimates.
9. If the management refuses to revise the estimates, and amounts involved are material, the auditor should modif report.
10. The audit risk is also increased and the auditor should co possibility of misstatement in other areas

While comparing accounts payable ledger with suppliers’ stat
you found significant difference in the balance per client’s b statement received from one of the supplier, Ravi traders.

The differences were caused because
(a) Some of the invoices in the statement received from the Ravi Traders, near year-end were not entered in the accounts payable ledger.
(b) Certain remittances per ledger were not reflected in the statement of account received form Ravi Traders.

What work would you perform to adjust the accounts?

a) For unrecorded invoices, check whether goods were received before year-end. If the goods have been received accrue the invoice, else ignore it.
b) For remittance in transit ascertain when the cheque was cleared. If it is subsequently cleared within a few days, it will appear in bank
reconciliation. If the cheque has been cleared say two weeks after the year-end consider the possibility that the client may not have dispatched the cheque before year-end but recorded in the cash book. In such case the entry should be reversed debiting bank and crediting accounts payable.

What procedures will you apply to verify unclaimed wages?

Procedures to verify unclaimed wages include:

1. Attend a wage pay-out
2. Obtain a copy of payroll sheet
3. Check that a pay packet is prepared for each employee on the payroll sheet.
4. Observe that when an employee receives his pay packet he signs for it.
5. Mark on the copy of payroll sheet the workers who collect their pay packets.

6. Observe whether each employee receives only one pay packet.
7. Note that the supervisor identifies each worker.
8. At the end of payout, compare unmarked names with available pay packets.
9. Verify record of unclaimed wages.
10. Ensure that unclaimed wages have been banked after say two weeks.

How will you verity liability under finance tease?

1. Inspect the lease
2. Verify allocation of payments under repayment of principal and interest
3. Obtain confirmation from lessor
4. Check that the liability has been initially recorded at the fair value of leased property, or if lower, at the present value of minimum lease payments.
5. Verify the reconciliation between the total minimum lease payments at the balance sheet data, and their present values.

6. Check that a disclosure has been made of the total minimum lease payments at the balance sheet data and their present values, for each ofthe periods:

(i) not later than one year
(ii) later than one year but not later then five years
(iii) later than five year

7. Verify general description of the lessee’s significant leasing arrangements.

You are the auditors of Abaseen Enterprises for year ended December 31, 20×8. The company plans to discontinue the operation of one of its lines of business. A board decision to restructure has been taken before the year end. A provision of Rs. 5 million has been made in the accounts of20x8 for restructuring, on the grounds of constructive obligation What audit evidence would you seek to verify that the entity has started to implement a restructuring plan?

IAS 37 Provision, Contingent Liabilities and Contingent assets, provides that a constructive obligation to restructure arises when an entity has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it. A management or board decision only to restructure taken before the balance sheet date does not give rise to a constructive obligation at the balance sheet date. Audit evidence that the entity has started to implement restructuring plan would be provided by
• Dismantling plant
• Selling assets
• Public announcement of the main features of the plan
• Implementation needs to be planned to begin as soon as possible
• Restoring to be completed in a time frame that makes significant changes to the plan unlikely

You have been appointed by sales tax department to audit a sales tax refund claim from’ a registered person. Write a brief audit program setting out essential audit procedures.

Audit program – sales tax refund

1. Ascertain whether the registered person has a right to claim a refund A registered person can claim sales tax refund under following circumstances.
• Total deductions on account of input tax and any other allowed adjustment exceed the amount of output tax.
• Where a registered person has paid sales tax at the time of taking delivery of plant and machinery is not making any taxable
Where a person is making zero based supply of such goods on which he has paid input tax at the time of taking delivery of those goods.

2. Verify following supporting documents in support of refund claitns
• Input tax invoices and or as the case may be, bill of entry
• Tax invoices of intermediary processes, if applicable
• Output tax invoices in case of domestic supplies
• Zero rated invoices in case of export
• Bills of exports indicating Mate Receipt number and date or as the case may be, airway bill number, railway receipt number an date or postal receipt number and date, along with examination report recorded by the custom officers.
• Bill of lading and airway bill indicating transportation of goods
out of Pakistan.
• Inventory statement indicating in terms of value and unit of ” quantity stocks of inputs and outputs carried over from the previous tax period additions in such stocks, stocks consumed or supplied during such period and stock in balance.
• In case of commercial exporter, bank credit advice issued by the concerned bank.
• In case of investors, verify • Tax invoices indicting import or purchase of plant and machinery:
Ownership document of premises where such plant is installed

Rent deed in case of rented premises

Installation certificate issued by the designated officer of sale tax collectorate
2. Ascertain reasons for seeking refund
3. Ensure that the refund is claimed after adjustment of all tax liabilities payable under any law administered by the Central Board of Revenue.
4. In case of zero rated supplies check that the input tax is adjusted against output tax and the balance is claimed as refund

Your client uses a pensiori plan for the employees. The plan provides that amounts to be paid to employees is determined by reference to last salary and years of services.
If the plan assets have suffered losses, the employer will have to compensate for such losses, and any gains will accrue to employer. Periodic charge to income .statement is therefore not constant. equired scribe audit procedure that you will perform to: Verify pension liability and expense

Procedures to verify liability and expense are:
1) Check estimates of benefits that the employees have earned in the current and prior period.
2)Assess reasonableness of estimates of employee turnover, mortality, and increases in salaries.
3)Check the discounted benefits using the Projected Unit Cost Credit method.
4) Verify fair value of plan assets
5) Determine total amount of actuarial gains and losses
6) Determine past service costs (where plan has been established or hanges have been made in the plan)
7)Determine gain or losses on curtailment or settlement of plan. nal advice may be required for last expected salaries, inflation future returns on investments, and life expectancies.

You are the manager on the audit of Noble Limited, a listed company, which manufacture automotive parts and air-conditioners for major . vehicle assemblers. Annual sale of the Company is Rs. 850 million and profit before tax is Rs. 60 million.
Your review of the audit working paper file has disclosed the following outstanding issues:

(i) The company is facing a potential legal claim from Mehran Motors Limited (MML) in respect of defective air condition rs
supplied to them: A claim for Rs. 25 million being the cost of replacement of air conditioners and lost production time has been lodged with the Company by MML. The management is of the view that the claim is not justified, as the air conditioners were properly functioning and had been tested for quality and that the effects have arisen because of the negligence of MML and its technicians. However, a provision of Rs. 2 million has been made in the financial statements in this respect. (ii) Depreciation on certain equipment has been charged at 10% per annum on reducing balance method. This rate is consistent with prior years and the same rate is being used by most other companies, in the automobile industry. However, significant losses have recently been recorded on the disposal of similar equipment.
Management has provided written representations in respect of the above matters. 

(i) Some of the significant evidences to be obtained are:

The auditor should obtain legal opinion from the legal advisors of the company as regards probable outcome of the case.
Contract with Mehran Motors Limited to be studied. Correspondence with other major customers to whom similar items have been supplied, should be inspected. The auditor should consider hiring an expert to give independent opinion on the validity of claim. The auditor should inquire management the basis of making a provision of.Rs. two million. .

(ii) The auditor should consider:
• Opinion of independent expert.
•  Production load and maintenance policies
• The fact that there have been significant losses on disposal, may be an indication of inadequate allowance for depreciation.

Your client uses a pension plan for the employees. The plan provides that amounts to be paid to employees is determined by reference to last salary andyears of service.
If the plan assets have suffered losses, the employer will have to compensate for such losses and any gains will accrue to employer. Periodic charge to income ‘statement is therefore not constant. 


Describe audit procedure that you will perform to:
(a) Verify pension liability and expense
(b) Pension payments

(a) Procedures to verify liability and expense are:
(i) Check estimates of benefits that the employees have earned in the current and prior period.
(ii) Assess reasonableness of estimates of employee turnover, mortality and increases in salaries
(iii) Check the discounted benefits using the Projected Unit Cost Credit Method.
(iv) Verify fair value of plan assets
(v) Determine total amount of actuarial gains and losses
(vi) Determine past- service costs (where plan has been established or changes have been made in the plan)
(vii) Determine gain or losses on curtailment or settlement of plan. Actuarial advice may e required for last expected salaries, inflation rates, future returns on investments and life expectancies.

(b) Pension payments

(i) Assess controls to ensure that the pension is paid to right persons and whether the pensioners exist
(ii) Trace the payment to cash book
(iii) Verify that correct amount is paid
(iv) Check authorization
(v) Obtain direct confirmation from pensioners
(vi) Compare month to month pension payments and investigate unusual or large differences

How would you verify that employees benefits have been appropriately _ classified in the financial statements?

Employee benefits should be classified under the following headings:
(a)  Short term employee benefits.
(b)  Pensions and other post employment benefits.
(c) Termination benefits.
(d) Other long term employee benefits such as long service leave, jubilee benefits, long term disability benefits.

You are the audit incharge of Kerr Pharmaceutical. The company operates a defined benefit plan. The Company’s net obligation in respect of defined plant is calculated by estimating the amount of future benefits that employees have earned in return for their services in current and prior periods. The benefit is discounted to determine its present value. The calculation is performed annually by a qualified actuary. Contributions require assumptions to be made of future outcomes whichmainly includes increase in remuneration, expected long term return on plan assets and the discount rate used to convert future cash flows to current values.
Calculations are sensitive to changes in the underlying assumptions. Prepare an audit plan for your assistant to verify the amounts reported in financial statements as regards defined benefit plan.

1. Obtain or prepare a lead schedule of benefit plan.
2. Trace opening balances with last year’s working papers.
3. Trace total to general ledger and statement of financial position.
4. Ensure that both legal and constructive obligations have been provided for.
5. Recompute present value of defined benefit obligations and the fair value of any plan assets at end of year.
6. Inquire the method used to measure entity’s obligation and costs. The recommended method is the Projected Unit Credit Method
7. Recompute allocation of benefits to period of service.
8. Review reasonableness of actuarial assumptions regarding:
employee turnover mortality increase in salary increase in medical costs.
9. Assess reasonableness of discount rate by reference to market yield at the date of statement of financial position.
10. Verify deduction of the fair value of any plant assets from the carrying amount of obligation.
11. Ensure that the carrying amount of an asset is limited so that it
does not exceed the any unrecognized past service cost and actuarial losses.
12. Check that past service costs are recognized on a straight line basis over the average period unless the amended benefits become valid.
13. Recompute specified portion of the net cumulative actuarial gains and losses that exceed the greater of:
(a) 10% of the represent value of the defined benefit obligation and
(b) 10% of the fair value of any plan assets.
14. Ensure that the portion of actuarial gains and losses to be recognized for each defined benefit plan is the excess of 10% corridor limit at the end of the previous accounting period, divided by the expected average remaining working lives of the employees participating in that plan..

Narrow Street Limited is an auto parts manufacturing company. The Company offers product warranty to its customers. You are senior incharge on the audit of the Company for the financial year ended December 31, 2008. While reviewing the draft balance sheet, you have noted that the provision for product warranties has increased to Rs. 150 million as compared to Rs. 85 million in the previous year. The Company’s profit after taxation as appearing in the draft profit and loss

account is Rs. 50 million. Considering the significance of this change, you have decided to carry out a detailed test to verify the amount.

(a) Describe the matters that should be discussed with the seruor
management while carrying out the above verification.
(a) State the audit procedures to be performed in order to conclude
that product warranty liabilities are fairly stated in the financial
statements of the Company.

(a) Matters to be discussed with management

1. Changes in marketing policies relating to warrantees
2. Warrantee expense as percentage with sales, current year vs. last year
3. Assumptions used to estimate warranty claims
4. Any deterioration in the quality of products
5. Practice of other companies engaged in the same industry.

(b) Audit procedures

1. Review agreements and correspondence with :customers
2. Compare provision with subsequent claims to date of audit
3. Compare provision make in prior year with actual claims
4. Review estimate of costs to be incurred
5. Review consistency in the assumptions and cost estimation method.
6. In case of new products evaluate reasonableness of estimates
7. Obtain confirmation from lawyers for warranty claims.

Posted on November 3, 2015 in Verification (Substantive Procedures)

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