What Are Examples of Audit Procedures?

An audit procedure is a specific task auditors perform to gather evidence about a company’s financial statements. These procedures are designed to address specific risks related to different accounts and transactions. The evidence gathered allows an auditor to provide reasonable assurance that the financial reports are free from material misstatement.

Core Types of Audit Procedures

Auditors use a variety of procedures to gather sufficient and appropriate evidence. Inspection involves examining records, documents, or tangible assets. This could mean reviewing a sales contract to understand its terms or physically examining a piece of equipment to confirm it exists. This procedure provides direct evidence about the existence and details of assets or transactions.

Observation consists of watching a process or procedure being performed by others. For example, an auditor might observe a company’s employees conducting a physical inventory count. This procedure provides evidence about how a process is performed at a specific point in time, offering insight into the client’s internal controls.

Inquiry involves seeking information from knowledgeable persons, both financial and non-financial, inside or outside the entity. Auditors ask questions of management and staff about accounting processes or specific transactions. The evidence it provides often needs to be corroborated with other procedures because its reliability depends on the knowledge and objectivity of the person providing the information.

Confirmation is the process of obtaining a direct written response from a third party verifying the accuracy of information. A common example is an auditor contacting a company’s bank to confirm its cash balance or sending letters to customers to confirm the amounts they owe. This procedure is highly reliable because the evidence comes from an independent external source.

Recalculation involves checking the mathematical accuracy of documents or records. An auditor might re-calculate the depreciation expense for a group of assets or verify the totals on an invoice. This procedure directly verifies the accuracy of recorded amounts and other data.

Reperformance is the auditor’s independent execution of procedures or controls that were originally performed as part of the entity’s internal control. For instance, an auditor might reperform the aging of accounts receivable to ensure the company’s classification of outstanding invoices is correct. This tests the effectiveness of the company’s own control activities.

Analytical procedures involve evaluations of financial information by analyzing plausible relationships among both financial and non-financial data. This can include comparing current financial information with prior periods or budgets to identify unusual fluctuations. These procedures are used to identify areas that may require more detailed investigation.

Examples for Key Asset Accounts

Cash

When auditing cash, a primary procedure is the direct confirmation of balances with financial institutions. The auditor sends a form to every bank the company uses, requesting verification of account balances as of the financial statement date. This procedure provides strong evidence for the Existence assertion and helps verify the Rights and Obligations assertion.

Another procedure is testing the company’s bank reconciliations. The auditor obtains the year-end bank reconciliation for each account and vouches reconciling items, like deposits in transit, to the subsequent month’s bank statement. For example, a deposit listed as “in transit” on the December 31 reconciliation should appear as a credit on the January bank statement. This tests the Accuracy of the cash balance and addresses the Cutoff assertion.

Accounts Receivable

For accounts receivable, the most common audit procedure is external confirmation. Auditors select a sample of customer balances and send letters directly to them, asking them to confirm the amount they owe the company. This directly tests the Existence assertion but provides less evidence for the Valuation assertion, as a customer may confirm a balance without the ability to pay.

To address the Valuation assertion, auditors analyze the adequacy of the allowance for doubtful accounts. This involves examining the aging of accounts receivable, which categorizes balances by how long they have been outstanding. Auditors review past-due accounts and historical collection rates to assess if the company’s estimate for uncollectible accounts is reasonable.

Inventory

Observing the client’s physical inventory count is a standard procedure for auditing inventory. The auditor attends the count to observe procedures, make test counts, and inspect the inventory’s condition. Selecting items from the company’s count sheets and tracing them to the physical inventory tests for Existence, while selecting items from the physical inventory and tracing them to the count sheets tests for Completeness.

To test the Valuation of inventory, auditors perform price testing. They select a sample of inventory items from the final inventory listing and vouch the cost back to vendor invoices. For manufactured goods, they may examine cost-accounting records to verify the raw material, direct labor, and overhead costs assigned. This ensures inventory is recorded at the proper cost.

Examples for Liability and Equity Accounts

For accounts payable, a primary concern is the Completeness assertion, as companies may have an incentive to understate their debts. To address this, auditors perform a search for unrecorded liabilities. This involves examining cash disbursements made in the period after the balance sheet date. The auditor inspects supporting documentation for these payments to determine if the obligation existed at year-end and should have been recorded.

Another procedure for accounts payable is to reconcile vendor statements with the company’s payable listing. Auditors may request statements directly from major vendors and compare the amounts to the liability recorded by the company. This helps test both the Existence and Completeness of recorded payables and can highlight unrecorded invoices or disputes.

For long-term debt, auditors examine new and existing debt agreements. This procedure helps verify terms like interest rates, maturity dates, and restrictive covenants, which supports the Valuation and Presentation assertions. Reading the agreements helps ensure interest expense is calculated correctly and that the debt is properly classified on the balance sheet.

Confirming balances and terms directly with lenders is also a standard procedure. The auditor will send a request to the financial institution to verify the outstanding principal, accrued interest, and compliance with any covenants. This provides strong external evidence for the Existence, Obligations, and Valuation assertions.

Examples for Income Statement Accounts

Auditing revenue is a focal point because it is susceptible to misstatement. A procedure is performing cutoff testing to ensure revenue is recognized in the correct accounting period. Auditors select a sample of sales transactions recorded immediately before and after the fiscal year-end. They examine shipping documents and sales invoices to verify that revenue was recorded when the company fulfilled its performance obligation, which directly tests the Cutoff assertion.

To test the Occurrence assertion for revenue, auditors perform substantive analytical procedures. This might involve developing an expectation for revenue based on non-financial data, such as production volume, and comparing it to the recorded revenue amount. Significant, unexplained differences could indicate that fictitious sales have been recorded.

Vouching a sample of recorded sales transactions back to supporting documents like customer purchase orders and shipping documents also tests for occurrence.

For expenses, a common procedure is to test for both Occurrence and Accuracy. Auditors select a sample of expense transactions from the general ledger and vouch them to supporting documentation. For example, a recorded utility expense would be traced to a utility bill, and a payroll expense would be traced to timecards and payroll registers.

Auditors also perform analytical procedures on expense accounts to identify potential misstatements. They might compare expense balances to the prior year or to budgeted amounts, investigating any large or unusual variances. For instance, a significant decrease in repairs and maintenance expense could suggest that some costs were improperly capitalized as assets. This procedure helps test the Completeness and Classification of expenses.