What Are the Audit Assertions for Expenses?

An audit of a company’s financial statements involves a detailed examination to ensure they are accurate and fairly presented. When it comes to business expenses, this process is particularly focused. Auditors don’t just accept the numbers on the income statement; they use a structured framework to test them. This framework is built on a set of “assertions,” which are claims made by a company’s management about the financial information. For every expense reported, management implicitly asserts that it is real, complete, and correctly recorded. The auditor’s job is to gather evidence to verify these claims, ensuring that the expenses shown are a true reflection of the company’s operations during the period.

Core Assertions for Auditing Expenses

The process of auditing expenses is guided by several core assertions. These assertions act as a roadmap for the auditor, directing their focus to specific risks of misstatement, such as fictitious transactions or incorrect accounting entries.

A primary assertion is Occurrence, which verifies that recorded expense transactions actually happened and relate to the business. Auditors test this to prevent the overstatement of expenses from errors or attempts to report lower profits. For example, an auditor might scrutinize a marketing expense by examining the contract with the advertising agency to confirm the campaign ran during the period. This ensures the expense isn’t for a service that was never delivered.

The Completeness assertion addresses the risk that some expenses have been omitted from the records, which would overstate net income. An auditor might test for completeness by reviewing payments made shortly after the fiscal year ends. If a large payment in January is for services rendered in December, the auditor verifies that the expense was properly accrued in the correct period’s financial statements.

Accuracy focuses on whether the amounts and other data for expenses are recorded correctly. An error in calculation or data entry can lead to a misstatement. For instance, when examining payroll, an auditor might recalculate tax withholdings for a sample of employees. This assertion also applies to non-cash expenses like depreciation, where the auditor would check that the correct asset cost and useful life were used.

The Cutoff assertion is concerned with timing, ensuring that transactions are recorded in the proper accounting period. Improper cutoff can distort the financial results of two consecutive periods. An invoice dated December 30 for goods received on that day should be recorded as an expense for that year, not postponed until the payment is made in January.

Classification relates to recording expenses in the appropriate account. Misclassification can skew the analysis of a company’s operations, even if it doesn’t change net income. An auditor might review maintenance expenses to ensure that costs that extend an asset’s life, which should be capitalized, have not been improperly expensed. For example, a new engine for a truck should be a capital expenditure, not a simple repair.

The Presentation assertion deals with how expenses are aggregated, disaggregated, and described in the financial statements and notes. This ensures the information is understandable and complies with accounting standards, which often require certain expenses to be disclosed separately. An auditor would review the income statement to confirm items like interest expense are presented as a distinct line item and significant expenses are explained in the notes.

Audit Procedures to Test Expense Assertions

Auditors employ specific procedures to gather evidence and test management assertions for expenses. These tests are designed to target the different risks associated with each assertion. The selection and extent of these procedures depend on the auditor’s assessment of the risk of material misstatement.

One procedure is Vouching. This involves selecting an expense entry from the general ledger and tracing it backward to the underlying source documents. For example, an auditor might select a large payment to a vendor and vouch it to the approved vendor invoice, purchase order, and receiving report. This process tests the Occurrence assertion by confirming the expense is legitimate and the Accuracy assertion by verifying the amount.

The opposite of vouching is Tracing. An auditor starts with a source document, such as a vendor invoice, and traces it forward to ensure it was recorded in the general ledger. Tracing is the primary test used to verify the Completeness assertion, as it can detect any expenses that were omitted from the financial records.

Analytical Procedures involve evaluating financial information by studying plausible relationships among financial and non-financial data. For expenses, an auditor might compare the current year’s expense balances to prior years, budgeted amounts, or industry averages. An unexpected 50% increase in travel expenses when the company’s sales force has not grown could signal a misstatement, prompting further investigation.

Cutoff Testing is a procedure designed to address the cutoff assertion. Auditors select a sample of transactions recorded in the days immediately before and after the fiscal year-end. They will examine shipping documents and invoices to verify that the expense recording aligns with the delivery of goods or rendering of services. This ensures expenses from the new period are not back-dated.

Reviewing Account Reconciliations prepared by the company is another test. For expense-related accounts like accrued liabilities, auditors examine the reconciliation between the general ledger balance and the underlying detailed records. They investigate old or unusual reconciling items. This procedure provides evidence for the Accuracy of the balance and the Completeness of the recorded liability.

The Role of Internal Controls Over Expenses

A company’s internal controls are policies and procedures implemented to ensure the integrity of financial reporting and prevent fraud. For expenses, these controls are the first line of defense against misstatements. An auditor’s assessment of these internal controls influences the nature and scope of the audit procedures they perform.

Segregation of Duties is a control that requires different individuals to be responsible for different parts of a transaction. For expenses, the person who authorizes a purchase should not be the same person who processes the payment or reconciles the bank account. This separation makes it more difficult for fraudulent payments to be made, as it would require collusion between employees.

Authorization and Approval processes are another control. Companies should have clear policies dictating who has the authority to approve expenses and up to what amount. For example, an employee’s expense report might require approval from their direct manager, while a large capital expenditure might require approval from a vice president. This ensures that expenses are legitimate and aligned with the company’s objectives.

Regular Reconciliation and Review activities provide a detective control to catch issues after they occur. This includes management regularly comparing actual expenses to budgeted amounts and investigating significant variances. It also involves the periodic reconciliation of accounts, such as matching the accounts payable subsidiary ledger to the general ledger control account. These reviews can uncover errors, identify potential fraud, and provide insight into operational inefficiencies.