Understanding Assertions in Audit and their Types
Assertions are an important aspect of auditing. Audits are done to verify financial statements and when financial statements are prepared by business owners, they assert that the information contained therein is accurate.
In this blog, we have thrown light on the meaning and types of audit assertions.
Meaning of audit assertions
Assertions are representations made by the management, whether explicitly or otherwise, regarding the recognition, measurement and disclosure of various elements of financial statements.
These are embodied in the financial statements and in a way represent that those financial statements have been prepared in accordance with relevant standards and policies. It is now on the auditor to check the accuracy of these assertions. The auditor has to check these assertions to consider the possibility of different types of misstatements that may be present in the client’s books.
In simple words, assertions are characteristics of financial records and disclosures that have to be tested. Through such assertions, the management (usually impliedly) claims that records are accurate, complete and correct.
We know that one of the primary goals of auditing is to give information on the credibility of financial statements to users such as creditors, investors and other stakeholders. But for doing so, the auditor has to see that the assertions in financial statements are neither overstated/understated nor misrepresented.
Types of assertions in audit
Assertions in audit can broadly fall into three categories:
|Classes of transactions and events||Account balances||Presentation and disclosure|
Rights and obligations
Valuation and allocation
|Occurrence and rights and obligations|
Classification and understandability
Accuracy and valuation
For different classes of transactions and events for the period under audit, an auditor needs to confirm the following assertions:
1. Occurrence: That transactions and events that are recorded in the books have actually occurred during the period under audit and that they pertain to the entity.
2. Completeness: That all transactions and events which should have been recorded are recorded (no transaction is missing).
3. Accuracy: That all transactions and events have been recorded appropriately at correct amounts.
4. Cut-off: That the transactions and events have been recorded in the correct accounting period.
5. Classification: That the recording of transactions and events is done in the proper accounts.
For account balances at the year-end, an auditor needs to confirm the following assertions:
1. Existence: That assets, liabilities and equities exist.
2. Rights and obligations: That the company holds rights against the assets and that liabilities represent the obligations of the company.
3. Completeness: That all assets, liabilities and equities which should have been recorded are recorded.
4. Valuation and allocation: That all assets, liabilities and equities are included in the financial statements at appropriate & correct amounts and any valuation/allocation adjustment is also recorded properly.
Regarding presentation and disclosure of items, an auditor needs to confirm the following assertions:
1. Occurrence and rights and obligations: That the disclosed transactions, events, etc. have actually occurred during the period under audit and that they pertain to the entity.
2. Completeness: That all disclosures which should have been done are done.
3. Classification and understandability: That the financial information is presented and expressed in a clear and understandable manner.
4. Accuracy and valuation: That the financial information is appropriately disclosed at correct figures.
In addition to the above assertions, in the case of financial statements of certain entities where Government is a major stakeholder, their management may further assert that transactions and events have been carried out in accordance with legislation or proper authority.
Moreover, the auditor may use the assertions as indicated above or express them differently, as long as all of the aspects described above are addressed. The auditor, for example, may opt to combine assertions about transactions and events with assertions about account balances.
Examples of assertions
Now, let us understand audit assertions with the help of some examples. It should be understood that each item contained in the financial statements asserts something or the other to the readers of the accounts, be it to indicate ownership, existence, or quantity of various things. And an auditor should be concerned with checking the authenticity of the information that is so conveyed.
For example, if in a company’s balance sheet, we see an item under current assets shown as “cash in hand – Rs. 15,000”, the obvious assertions that one would think of are:
- The concerned company had Rs. 15,000 in hand in valid notes and coins on the date of the balance sheet.
- Such cash was free and available to the company for expending.
- On the date on which the balance sheet is drawn up, the company’s books of account show an identical amount of cash balance (in the cash book).
To take another example, assume the following details appearing in a company’s balance sheet:
Plant and Machinery (at cost): Rs. 2 lacs
Less: Depreciation till the end of the previous year: Rs. 70,000
Less: Depreciation for the year: Rs. 13,000
Balance: Rs. 1,17,000
From the above information, the obvious assertions that one would think of are:
- The “plant and machinery” is owned by the company.
- The historical cost of the asset is Rs. 2 lacs.
- The “plant and machinery” is physically existent.
- The asset is productively utilized in the company’s operations.
- The total depreciation charged on the asset is Rs. 83,000 to date, out of which Rs. 13,000 relates to the year for which the accounts are being closed.
- The calculation of depreciation is correct and it is charged on an appropriate basis.
From the above examples, it is clear that assertions are normally implied in financial statements. Auditors have to obtain sufficient audit evidence to support or otherwise contradict these assertions made by a company’s management.
Moreover, besides the specific assertions discussed so far, every financial statement also contains an overall representation and purports to show something as a whole. For example, an income statement purports to show the results of a company’s operations and a balance sheet purports to show the financial position.
An auditor’s opinion is directed towards these overall representations. But bear in mind that to give an opinion on the overall truthfulness of these statements, he has to first test the specific assertions about each and every item, transaction, or account balance.
Once he forms a judgment on the specific assertions of individual items, he can arrive at a judgment on the financial statements as a whole.
What kind of evidence does an auditor obtain to prove audit assertions?
The extent of evidence to be obtained has to be determined by the auditor in the context of materiality. Materiality refers to the significance of account balances or transactions to the users of financial statements.
If assertions are less material to the users of financial statements, they require less evidence and if assertions are more material, they require more evidence.
To prove assertions in an audit, the auditor uses substantive procedures to obtain the relevant evidence. They comprise tests of detail and substantive analytical procedures.
Substantive procedures (also known as substantive tests) are those activities that are performed by an auditor to gather evidence with respect to the completeness, validity, and accuracy of account balances and underlying classes of transactions of the client’s business.
For this purpose, some of the techniques that auditors adopt to gather evidence are inspection of documents or physical assets, observation, making inquiries to the client or a third party, obtaining external confirmations, analytical review procedures, reperformance and computations.
Given below are a few points that may be observed by them in deciding the techniques to be used for obtaining evidence:
- The reliability of evidence varies. When the auditor recalculates specific data, such as depreciation or inventory valuation, he may be entirely convinced of the accuracy of the company’s figure. However, the information provided by an employee may not be as credible because he may be more interested in concealing rather than sharing the truth. This implies that we should always be aware of the relative reliability of various types of evidence.
- Certain types of evidence may be more difficult to obtain than others. It is pretty simple to ask questions to employees who are present in the company. It is simple to inspect inventory that is on hand, but it is more difficult to evaluate inventory that is held elsewhere.
- When audit evidence obtained from diverse sources of varying nature is consistent, the auditor may gain more assurance. In contrast, if audit evidence obtained from one source is contradictory to that obtained from another, additional procedures may be required to address the inconsistency.
- The auditor should thoroughly make efforts to obtain evidence and should evaluate it objectively. In selecting the procedures to obtain evidence, he should always consider the possibility that the financial information of the client may be materially misstated.
- When the auditor has a reasonable doubt about an assertion, he should try to gather enough acceptable evidence to dispel that doubt. He should refrain from expressing an unqualified opinion if he is unable to collect enough evidence.
- A specific set of audit techniques may offer audit evidence relevant to some assertions but not others. Inspection of documents relating to the collection of receivables after the period end, for example, may give evidence regarding existence and valuation, but not necessarily cut-off. Similarly, having audit evidence for one assertion, such as the existence of inventory, is not a substitute for obtaining audit evidence for another, such as the valuation of that inventory.
An auditor obtains audit evidence to support or contradict the assertions made by management. He has to obtain sufficient information to check whether the assertions made by management are true or not.
He verifies each assertion in the Financial Statements by working backward and reviewing original entries made in the books of account as well as evidence to support the entries reported.
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