Audit Procedures Examples for Key Accounts

An audit procedure is a specific task an auditor performs to gather evidence about the accuracy and fairness of a company’s financial statements. These actions allow an auditor to collect sufficient and appropriate evidence to form an opinion on whether the financial information is free from material misstatement. This article provides examples of these procedures as they apply to major accounts within a company’s financial records.

Core Types of Audit Procedures

Inspection

Inspection involves examining records, documents, or tangible assets. For instance, an auditor inspects a signed contract to verify its terms and the existence of an agreement. This can be applied to internal documents, like an approved purchase order, or external documents, such as a bank statement.

Observation

Observation consists of looking at a process or procedure being performed by others. For example, an auditor observes a company’s employees conducting a physical inventory count to understand the process and see if controls are followed. The evidence provided is limited to the point in time at which the observation occurs.

Inquiry

Inquiry involves seeking information from knowledgeable persons within or outside the company through formal or informal questions. An auditor might ask management about the potential for inventory to become obsolete to assess the risk of overvaluation. Information from an inquiry usually requires corroboration through other audit methods.

Confirmation

Confirmation is the process of obtaining a representation of information or of an existing condition directly from a third party. This evidence is highly regarded because it comes from an independent source. A common example is an auditor sending a request to a company’s bank to confirm its account balances and any outstanding loans.

Recalculation

Recalculation consists of checking the mathematical accuracy of documents or records. For example, an auditor recalculates the depreciation expense on a company’s fixed assets to verify that the amount recorded is correct based on its stated depreciation policy.

Reperformance

Reperformance involves the auditor’s independent execution of procedures or controls that were originally performed by the company. For example, an auditor might reperform the aging of accounts receivable to check the accuracy of the company’s report. This differs from recalculation because it involves executing the entire process, not just checking the math.

Analytical Procedures

Analytical procedures consist of evaluating financial information by studying plausible relationships among financial and non-financial data. These procedures can be simple comparisons or complex models. For example, an auditor might compare a company’s gross margin percentage to the industry average and prior years to identify potential misstatements.

Audit Procedures for Cash and Receivables

For cash, auditors use bank confirmations by sending a form directly to all banks the company does business with. This form asks the banks to verify account balances, loan amounts, and terms as of the financial statement date. This provides strong, independent evidence of the company’s cash position.

Auditors also test bank reconciliations. They obtain the company’s reconciliation for each cash account to ensure it was properly prepared and reviewed. They then recalculate its mathematical components and agree the balance per the bank statement to the confirmation received from the bank, while vouching outstanding checks and deposits to subsequent bank statements.

To ensure transactions are recorded in the correct financial period, auditors perform cash cutoff testing. This involves examining cash receipts and disbursement journals for a few days before and after the year-end. These recorded transactions are traced to bank statements to confirm the dates correspond to the proper period.

For accounts receivable, auditors send confirmation letters directly to a sample of customers. These letters ask customers to verify the amount they owe the company. A positive confirmation requests that the customer respond whether they agree with the balance or not, while a negative confirmation only requests a response if there is a discrepancy.

To test the allowance for doubtful accounts, auditors review the company’s accounts receivable aging report. This report categorizes outstanding invoices by how long they have been due. Auditors will inquire with management about the collectability of overdue accounts and inspect supporting documentation to evaluate the company’s estimate for uncollectible amounts.

Auditors also use analytical procedures to assess the reasonableness of accounts receivable. A common analysis is calculating the days’ sales outstanding (DSO) and comparing it to the prior year and industry benchmarks. A significant, unexplained increase in DSO could indicate collection problems, suggesting receivables might be overvalued.

Audit Procedures for Inventory and Fixed Assets

For inventory, auditors observe the physical inventory count. The auditor is present at the warehouse or store to watch employees count stock. During this process, the auditor performs their own test counts on a sample basis and traces them to the final inventory listing to ensure accuracy.

During the inventory observation, the auditor also looks for signs of obsolete or damaged goods. They scan storage areas for items that appear dusty, have damaged packaging, or are otherwise not part of current sales stock. These items may need to be written down to a lower value, affecting the inventory’s valuation.

Auditors also perform inventory cutoff testing. They examine shipping and receiving documents, such as bills of lading and receiving reports, for several days before and after the fiscal year-end. This verifies that goods shipped before year-end are excluded from inventory, and goods received are included.

To test inventory valuation, an auditor selects a sample of items from the final inventory list and traces their costs to original vendor invoices. This verifies the cost of the inventory. The auditor then recalculates the value of the sampled items based on the company’s costing method, such as FIFO, to ensure it was applied correctly.

For fixed assets, auditors vouch additions by selecting a sample of new assets purchased during the year. They examine supporting documents like vendor invoices and purchase orders. This process verifies that the asset exists, its cost is accurate, and it is a legitimate capital expenditure.

Auditors also recalculate depreciation expense for fixed assets. They select a sample of assets and independently calculate the depreciation for the period using the asset’s cost, useful life, and the company’s stated method. The auditor’s result is then compared to the company’s recorded amount for accuracy.

Audit Procedures for Liabilities and Expenses

When auditing liabilities, a concern is completeness, meaning that all obligations that should be recorded have been. To address this, auditors search for unrecorded liabilities. They review cash disbursement records for payments made in the weeks following the fiscal year-end and inspect the supporting invoices to determine if the expense was incurred before year-end, which would indicate a liability that should have been recorded.

For accounts payable, auditors may send confirmation letters to major vendors asking for a statement of the amount owed. More commonly, they reconcile vendor statements with the company’s accounts payable listing. The auditor obtains statements from vendors and compares them to the company’s records, investigating any discrepancies.

For expenses, analytical procedures are a common testing method. Auditors compare current expense balances to prior years, budgets, and other operational data. For example, they might compare the trend of sales commissions expense to the trend of total revenue, investigating any significant or unexpected fluctuations.

To verify specific expense transactions, auditors perform vouching. They select a sample of transactions from the general ledger and examine underlying support like invoices and receipts. This ensures the expense was a legitimate business cost, properly approved, and recorded correctly.

Audit Procedures for Revenue and Equity

For revenue, auditors perform detailed tests to verify that recorded sales are legitimate. An auditor selects a sample of sales transactions from the sales journal and vouches them to supporting documents. These documents include the customer’s purchase order, the shipping document, and the sales invoice, which confirms the sale occurred and was billed correctly.

A sales cutoff test is also performed to ensure revenue is recognized in the correct period. The auditor examines shipping documents and sales invoices for transactions recorded around the year-end. This process verifies that the revenue was recorded when the company fulfilled its performance obligation, which is typically upon shipment of the goods.

For equity, auditors review the minutes from Board of Directors’ meetings. These minutes provide authorization for equity-related transactions. Auditors read these documents to find evidence of approvals for actions like issuing new stock, repurchasing shares, or declaring dividends.

When a company issues new stock, the auditor inspects related legal documents, such as the articles of incorporation, to verify the number of shares authorized and issued. They also trace the cash proceeds from the issuance to bank statements. The auditor may also confirm the transaction details with the company’s external legal counsel or stock transfer agent.