Lesson 31


Control objectives
The control objectives are to ensure that:
(i) Non current assets are correctly recorded, adequately secured and properly maintained
(ii) Acquisitions and disposals of non current assets are properly authorized
(iii) Acquisitions and disposals of non current assets are for the most favorable price possible
(iv) Non current assets are properly recorded, appropriately depreciated, and written down where necessary.

Control Procedures over Non Current Assets:
(i) Annual capital expenditure budgets should be prepared by someone directly responsible to the board of 
(ii) Such budgets should, if acceptable, be agreed by the board and put in the minutes.
(iii) Applications for authority to incur capital expenditure should be submitted to the board for approval 
and should contain reasons for the expenditure, estimated cost, and any non current assets replaced.
(iv) A document should show what is to be acquired and be signed as authorized by the board or an 
authorized official.
(v) Non current assets manufactured or constructed by the company itself should be separately identifiable 
in the company's costing records and should reflect direct costs plus relevant overhead but not
include any profit. This might apply where, for example, a building company constructs its own office
(vi) Disposal of non current assets should be authorized and any proceeds from sale should be related to the

(vii) A register of non current assets should be maintained for each major group of assets. The register
should identify each item within that group and contain details of cost and depreciation. 
(viii) A physical inspection of non current assets should be carried out periodically and checked to the non
current asset register. Any discrepancies should be noted and investigated. 
(ix) Assets should be properly maintained and adequately insured.
(x) Depreciation rates should be authorized and a written statement of policy produced.
(xi) Depreciation should be reviewed annually to assess the need for changes in the light of profits or losses 
on disposal, new technology etc.
(xii) The calculation of depreciation should be checked for accuracy.
(xiii) Non current assets should be reviewed for the need for any write-down.

(i) Check authorization of purchase to board minutes, capital expenditure budgets and capital expenditure 
(ii) Check authorization for disposals of significant assets.
(iii) Confirm existence of non current asset register which adequately identifies assets and comments on 
their current condition. Ensure register reconciles to nominal ledger.
(iv) Test evidence of reconciliation of register to physical checks of existence and condition of assets.
(v) Check authorization of depreciation rates, and particularly changes in rates.
(vi) Examine evidence of checking of correct calculations of depreciation.

The testing of controls is established whether they are working effectively. So, by this stage, the auditor will
know whether a systems approach is to be used - focusing on the accounting systems supplemented by a 
reduced amount of substantive testing, or a verification approach with full substantive testing.


We are now moving on to deal with the substantive testing, or verification aspect of the audit. In the past
lectures we have been learning the early steps in the time structure of an audit:
• Accepting the appointment
• Planning, recording, controlling the audit
• Evaluation internal controls
• Testing the controls
By this stage, the auditor will have made a decision on the general approach to be taken to the audit work. If
the controls systems are effective and operating as laid down, the amount of verification work will be reduced.
If the controls are weak or are not operating effectively, a high level of verification work will be performed. It
is this verification work that we are dealing with in this and the next few lectures.
To verify means to establish the truth of something. This audit work involves the audit in gathering evidence
this will lead to a conclusion as to whether classes of transactions, balances and disclosures reflected in the
client’s financial statements are properly stated (true and fair).
We have already discussed in detail the general audit verification principles; here we will have a brief over view
of those.
Audit Verification Techniques: 
As we have already discussed in the previous lectures that at the verification stage of the audit, the auditor is
typically presented with a set of draft financial statements prepared by the client. The role of the auditor is to
generate evidence to allow a conclusion to be reached as to whether the information contained in
these financial statements, and the way the information is presented and disclosed, give a true and
fair view.
We already know that audit evidences are generated by the auditor performing audit tests. Here, in verification
work, the auditor will use substantive testing procedures, designed to give evidence relating to the figures in
the financial statements, rather than control test, dealing with the systems that produced those figures.
However, the testing procedures available to the auditor here are the same as those we saw earlier. As a
reminder, audit-testing procedures available to the auditor are:
1. Inspection
This covers the physical review or examination of records, documents and tangible assets. An example in
substantive testing is examining purchase invoices to ensure that they have been properly recorded and
analyzed in the financial statements.
2. Observation
This procedure is mainly applicable to tests of control, but may also be used in substantive testing, such as the
auditor observing the client's inventory count to gain evidence that the inventory figure in the financial
statements had been arrived at accurately.
3. Enquiry 
Seeking relevant information from knowledgeable persons inside or outside the enterprise.
An example in substantive testing is asking management for an explanation as to why a receivable has, or has
not, been treated as bad.
4. Computation
Checking the arithmetical accuracy of records or performing independent calculations, for example computing
or re-computing the depreciation expense for the year.
5. Analytical procedures
You should note that these procedures are mainly used in substantive testing rather than as a test of controls.
They may help the auditor to understand relationships between figures in the financial statements. This is
sometimes referred to as the business approach to auditing.

Choice of Verification Techniques
There are no specific rules that exist as to the type(s) of techniques that the auditor should use in a given set of
This is principally a matter of audit judgment and the nature of the audit objective(s). The auditor has to look
at each individual item in its own right, identify the audit objective(s) for that particular item and then decide 

Lesson 32

the most reliable audit evidence available. The circumstances and evidence available will affect the type of
technique(s) he uses.

Audit Objectives and Financial Statement Assertions
As just stated the type(s) of technique(s) used depend on the audit objectives that the auditor is seeking to
The general objective to be achieved by audit verification work is to establish whether the financial statements
present a true and fair view.
We can identify a number of more detailed objectives which underlie this overall objective. These more
detailed objectives allow the auditor to design a series of substantive test on each audit area (inventory,
receivables, etc) which will build up the overall bank of evidence necessary to support the overall audit
In carrying out substantive audit tests (verification work) the auditor will be looking for evidence on different
assertions at the financial statements level. 
Assertions in obtaining Audit Evidence:
(a) Assertions about classes of transactions and events for the period under audit; 
(i) Occurrence – transactions and events that have been recorded have occurred and pertain to
the entity; 
(ii) Completeness – all transactions and events that should have been recorded have been
(iii) Accuracy – amounts and other data relating to recorded transactions and events have been
recorded appropriately. 
(iv) Cutoff – transactions and events have been recorded in the proper period.
(v) Classification – transactions and events have been recorded in the proper accounts. 
(b) Assertions about account balances at the period end.
(i) Existence – assets, liabilities, and equity interests exist;
(ii) Rights and obligations – the entity holds or controls the rights to assets, and liabilities are 
the obligations of the entity;
(iii) Completeness – all assets, liabilities and equity interests that should have been recorded 
have been recorded;
(iv) Valuation and allocation – assets, liabilities, and equity interests are included in the financial 
statements at appropriate amounts and any resulting valuation or allocation adjustments are
appropriately recorded. 
(c) Assertions about Presentation and Disclosure:
(i) Occurrence and rights and obligations – disclosed events, transactions and other matters 
have occurred and pertain to the entity.
(ii) Completeness – all disclosures that should have been included in the financial statements 
have been included;
(iii) Classification and understandability – financial information is appropriately presented 
and described, and disclosures are clearly expressed;
(iv) Accuracy and valuation – financial and other information are disclosed fairly and at 
appropriate amounts.
This concept takes the view that draft accounts presented by the client to the auditor are making a number of
promises, or assertions. The role of substantive testing is to verify these assertions.

The assertions made by the financial statements and the related objectives of the substantive testing objectives
set out above can be shown as follows: 
Assets shown include all rights under the 
control of the enterprise

Transactions arising during the period are
reflected in the period's financial statements

The amounts at which assets and liabilities
are stated is correct 


Assets and liabilities included on the balance
sheet actually exist 
Assets and liabilities are shown in the
financial statements such that the user would
have a clear understanding of the client's
financial situatio

Presentation and

Review of Financial Statements
Content of Financial Statements
It is important that you are clear as to exactly what the financial statements consist of under modern
accounting practice.
They comprise the following:
a) The primary statements  
i) Balance sheet 
ii) Income statement
iii) Statement of changes in equity
iv) Cash flow statement
v) The notes to the accounts 
b) The directors' report
c) The auditor's report.
The main principles underlying the preparation and presentation of company financial statements are now set
out by the International Accounting Standards Board's document Framework for the Preparation and Presentation of
Financial Statements.
The major points from this document are summarized below:
1        The elements of Financial Statements
The starting point here is definitions of assets and liabilities. The other elements are then defined in terms of
 Assets are rights or other access to future economic benefits controlled by an entity as a result of past
transactions or events. 
 Liabilities are obligations of an entity to transfer economic benefits as a result of past transactions or
 Owners' equity is arrived at by deducting liabilities from assets (capital = assets - liabilities).  
 Gains and losses are determined in terms of increases and decreases in owners' equity.
2        Recognition in financial statements
Recognition essentially means the recording process. The principles here address such questions as when is it
acceptable to recognize (record) an asset or liability and when should assets and liabilities be de-recognized (no
longer recorded in financial statements). The main points to note are: 
 Assets and liabilities should be recognized when there is evidence of their existence and they can be
reliably measured. 
 They should be derecognized when the right (assets) or obligations (liabilities) no longer exist.

The Timing of Audit Procedures:
Whereas tests of control can be (and usually are) performed by the auditor before the client's year end - at the
so called interim audit stage - Substantive Audit Procedures and verification work will be performed
primarily at or very soon after the client's year end, as these procedures normally rely on the availability of
draft financial statements.
Verification of the individual assets and liabilities by the auditor extends into the post balance sheet period (i.e.
the period between the year end date and the date of approval of the financial statements). The auditors will
use this to their advantage when seeking to verify amounts stated for contingent liabilities, and for post 
balance sheet events (These are explained in a later chapter).

Substantive procedures are performed in order to detect material misstatements at the assertion level (Like;
occurrence, completeness, accuracy, valuation, existence, rights and control), and include tests of details of
classes of transactions, account balances and disclosures and substantive analytical procedures.  

Nature of Substantive Procedures 
• Tests of details are ordinarily more appropriate to obtain audit evidence regarding certain assertions about
account balances, including existence and valuation. 
• Analytical procedures are applied on large volume of transactions, which are predictable over time. (Cost of
goods sold, payroll, sale) 

Timing of Substantive Procedures

Year end substantive procedures are always more reliable

In considering whether to perform substantive procedures at an interim date the auditor considers such
factors as the following: 
• The control environment and other relevant controls. (Like payroll disbursement)
• The availability of information at a later date that is necessary for the auditor’s procedures (Provision 
for doubtful debts can be investigated interim but debtor and inventory can be verified at the year
• The objective of the substantive procedure.
• The assessed risk of material misstatement (Prefer always at year end).
• The nature of the class of transactions or account balance and related assertions (Like frequency of 
occurrence of the transactions e.g. salaries are paid monthly whereas bonuses are paid annually).
• The ability of the auditor to perform appropriate substantive procedures or substantive procedures 
combined with tests of controls to cover the remaining period in order to reduce the risk that
misstatements that exist at period end are not detected (Staffing problem that cannot make the
auditor able to extend till the year end) 
If substantive procedures are performed at an interim date, the auditor may sometimes consider applying tests
of controls also on the transactions of remaining period while extending his substantive procedures from
interim date to the period end.

Extent of performance of substantive procedures
Greater the risk of material misstatement due to weaknesses in the system of internal control, the greater
would be the risk of material misstatement in the financial statements.
In designing tests of details, the auditor may use either audit sampling or may choose to select items to be
tested by some other selective means of testing.


VOUCHING = Inspection of supporting documents and records.
VERIFICATION = Inspection, Observation, Enquiry, Computation, Analysis
A large part of the final audit stage will be taken up with the verification of the assets and liabilities appearing
in the balance sheet. There are well established techniques for verifying specific assets and liabilities.  
Following few lectures will cover verification of assets, liabilities and equity.
Verification of Assets
Auditor has a duty to verify all the assets appearing on the balance sheet and also a duty to verify that there are
no other assets which ought to appear on the balance sheet.
Following aspects of assets must be verified: 
1. Cost 
2. Authorization 
3. Value
4. Existence
5. Beneficial Ownership
6. Presentation in the accounts 
These aspects can be remembered by the mnemonic CAVE BOP.
While verifying assets at a balance sheet date, it is possible to divide the assets into two classes: 
1. Those acquired during the year under review.
2. Those held at the date of the previous balance sheet. 
For the assets acquired during the year it will be necessary to vouch their acquisition. For this purpose cost and
authorization aspects are verified. 
For the assets held at the beginning of the year, the acquisition would have been dealt within a previous year.
The other aspects like value, existence, beneficial ownership, and presentation in financial statements are verified in this
regard. Of course, these need to be consistent with the previous years. 

Verification Methods:
a. Make or request from client's staff a schedule
of each asset. This schedule will show   the following and 
suggest the associated verification procedures:
i. Opening balance  
a. Verify by reference to previous year's balance sheet and audit files, 
ii. Acquisitions 
b. Vouch the cost with documentary evidence e.g invoices.
c. Vouch the authority for the acquisition with minutes or with authorized delegated 
iii. Disposals

 -.  Vouch the authority - minutes or company procedures.    
a. Examine documentation.    
b. Verify reasonableness of the proceeds.
c. Pay special attention to scrapings.
d. Note accounting treatment.   
iv. Depreciation amortization and other write downs
a. Vouch authorization of policy with minutes.
b. Examine adequacy and appropriateness of policy. 
c. Investigate revaluations. 
d. Check calculations. 
v. The above should
reconcile both as to physical quantity and Rupees value of the closing 
vi. The use of
plant or other asset registers can be of great use to the auditor.
vii. Internal control procedures for the purchase, disposal, and maintenance of assets are very 
b. Existence and Ownership 

Lesson 33

These are treated together but note that existence does not imply ownership. For example, my television set
exists and is in my house, but is in fact owned by the person from whom I rent it. 
Verification procedures include: 
i) Physical inspection. Auditors should not sit in offices but should get about
seeing things. Of course, sitting in a client's office goes to confirm the existence of
that office! 
ii) Inspection of title deeds and certificates of ownership e.g., share certificates. This is a technique
that confirms together existence and ownership. Problems arise if the deeds are held by third
parties (a certificate from the third party is needed) possibly as security for a loan.      
iii) External verification. This applies primarily to 'chases in action' e.g., bank accounts, debtors,
loans etc. A letter of acknowledgement is sought from the bank, debtor etc. 
iv) Ancillary evidence. Examples are:
v) Confirmation of the existence of property by examination of rate (local taxes) demands, repair 
bills and other outgoings.
vi) Ownership is not necessarily implied. Investment ownership and existence tend to be confirmed 
by the receipt of dividends and interest.
c. Presentation and Value 
i) Appropriate accounting policies must be adopted, consistently applied, and adequately
ii) Accounting Standards must be followed.
iii) Materiality must be considered. For example, in a balance sheet of a large company it would be 
misleading to show an asset such as patents in a class by itself it its total value was negligible in
relation to other assets. 
iv) The classification of assets can be difficult. Certain industrial structures can be considered as
buildings or as plant with consequent major differences in depreciation, profit, and asset and
equity values. A number of interesting examples have cropped up in tax cases. A dry dock
including the cost of excavation has been held to be plant (Barclay Curie 1969), as has a
swimming pool for use on a caravan site (Beach Station Caravans 1974). The auditor may take a
contrary view to the tax courts and of course to the Board of the Company he is auditing. 
v) The choice of disclosure of an asset as a separate item or as part of a single figure representing a
class of asset is important for a true and fair view. Also important is the choice of words used in
the description. In some cases, assets could be classed as fixed or as current e.g. investments. 
vi) The distinction between revenue and capital is important. Sometimes this is a matter of
accounting policy e.g. research and development. Sometimes it is a matter of opinion; for example
repair expenditure is revenue but may include an element of improvement which is capital. 
d. Other matters relevant to verification  
i) The letter of representation. This will be discussed in detail in the next lecture.
ii) Reasonableness and being 'put upon enquiry'. In all audit assignments, the 
auditor investigates thoroughly and seeks adequate assurances on the truth and 
fairness of all the items in the Accounts. However, he does not do so with a
suspicious mind. He should not assume that there is something wrong, but if he
comes across something which seems to him unlikely, unreasonable, suspicious
he is said to be 'put upon enquiry'. In such circumstances he is required to probe the
matter to the bottom to adequately assure him-self that there exists nothing untoward or to unearth
the whole matter. 
iii) Some assets are pledged or mortgaged as securities for loans. This may involve deposit of title
deeds etc., with a lender, or in some cases the asset itself. This creates problems for the auditor
who must also see that the liability is properly described as secured. 
iv) Taxation. Tax and capital allowance computations should be in accordance with asset accounts.
Clearly the auditor will be put upon enquiry if claims for capital allowances are made for items of 
plant which do not appear in the plant register.
v) Insurance. The auditor would be put upon enquiry if there were no correspondence between the 
assets in the balance sheet and the assets insured, and if there were differences between the
balance sheet figures and the insured values. 

vi) Other than balance sheet date verification. Some assets can be verified at dates other than the
balance sheet date. The techniques are discussed later but in sum (money value) they are:
a. Verify at an earlier date and reconcile with acquisitions and disposals to balance sheet date.
b. Verify at an earlier date and then parcel them up and seal the parcels. At balance sheet date 
examine acquisitions, vouch proceeds of disposals, and see all other items are still sealed.
vii) Third parties. Auditors must take special care to satisfy them-selves that all assets held by third 
parties are included in the balance sheet and verified. Likewise, no assets owned by third parties
may be included in the balance sheet. 


Letter of Representation
It is now normal audit practice for the auditor to obtain a letter from the management addressed to the auditor
confirming any representations given by the management to the auditor. This letter is known as the
management letter or the letter of representation.
Representations in this context can be defined as a statement made to convey an opinion.
Reasons why the letter of representation is obtained
Auditors are required to carry out procedures designed to obtain sufficient appropriate audit evidence to
determine with reasonable confidence whether the financial statements are free of material misstatement.
Representations from management are a source of evidence.

Management representations as Audit Evidence
In the course of an audit, numerous questions are asked of the client's management and staff. Replies are
usually verbal. Most of the queries are: 
a. Not material to the financial statements. Examples are queries re missing documents or errors in
bookkeeping, or 
b. Capable of being corroborated by other evidence. For example, provisions in respect of litigation can
be confirmed by the client's solicitors or the life of plant can be confirmed by examining technical
However, in some cases:
a. Where knowledge of the facts is confined to management, for example, the management's intentions 
to close or keep open a material loss-making branch. This would have an affect on the value of the
assets at the branch. 
b. Where the matter is principally one of judgment and opinion, for example, the readability of old
stock. Then: 
i. The auditor should ensure that there is no conflicting evidence;
ii. The auditor may be unable to obtain corroborating evidence;
iii. The auditor should obtain written confirmation of any representations made; 
The auditor must decide for himself whether the total of other evidence and management's written
representations are sufficient for him to form an unqualified opinion.

The following procedures should be adopted: 
a. The auditor should summarize in his working papers all matters that are material and also subject to
uncorroborated oral representations by management, 
b. In addition these matters should be either.
i. Formally minuted as approved by the Board of Directors at a meeting ideally attended by the 
ii. Included in the signed letter of representation. 
c. Standard letters should not be used as:
i. Each audit is different;
ii. The letter is important and should receive very careful attention;
iii. The management should participate in its production. There should be much drafting, review 
and discussion.
d. The letter should be: 
i. Signed at a high level – e.g. chief executive, financial director; 
ii. Approved and minuted at a board meeting at which, ideally, the auditor would be present.
The preparation of the letter should begin at an early stage, e.g. at the beginning of the final audit in 
order to avoid the possibility of the auditor being faced with a refusal to sign by the management. If
there is a refusal by management to cooperate then the, auditor should: 
i. do all he can to persuade management to cooperate; 

Lesson 34

ii. prepare a statement setting out his understanding of the principal representations made, with
a request that management confirm it; 
iii. if management disagree with this statement, discuss and negotiate until a correct
understanding has been reached; 
iv. if management refuse altogether to cooperate, either on principle or because the are
themselves uncertain about a particular matter, consider if he has obtained al the
information and explanations he requires and consequently may need to qualify his
report on grounds of limitation of scope. 
f. The representation letter or board resolution making representations should be approved as late as
possible in the audit, after the analytical review, but, as it is audit evidence, before the audit report is
prepared. If there is a long delay between the approval of the representation and the audit report, the
auditor may need to do the: audit work/or obtain a supplementary letter of representation. It is
suggested to dating the letter on the day the financial statements are approved. 
The contents of the letter of representation should not include routine matters, for example, that all fixed
assets exist and are the property of the company or that stock is valued at the lower of cost and net realizable
The letter should include only matters which: 
a. are material to the financial statements, and
b. the auditors cannot obtain independent corroborative evidence. 

Example of a Letter of Representation
To ABC & Co. 
Chartered Accountants
We confirm that to the best of our knowledge and belief, and, having made appropriate enquiries of other
directors and officials of the company, the following representations given to you in connection with your
audit of the company's financial statements for the year ending 31st December 20x7:
1.  We acknowledge as directors our responsibility for the financial statements, which you have prepared for
the company. All the accounting records have been made available to you for the purpose of your audit and all
the transactions undertaken by the company have been properly reflected and recorded in the accounting
records. All other records and related information, including minutes of all management and shareholders'
meetings, have been made available to you.
2. The provision for warranty claims has been estimated at 2% of annual turnover as in previous years. This
amount is in accordance with our opinion of the probable extent of warranty claims.  We know of no events
which would materially affect the amount of these claims
3.     As stated in Note 12 to the Accounts, there exists a contingent liability in respect of the company's
guarantee of the bank overdraft of NBG Ltd, an associated company now in receivership. In our opinion the
assets of NBG Ltd will realize sufficient to satisfy the bank and no actual liability will arise. 
4.     It is the intention of the Board of Directors to continue production for at least the next three years so
that valuation of the assets and liabilities of that plant should appropriately be on the going concern basis

Yours Sincerely,
Company Secretary 
Signed on behalf of the Board of XYZ Co Ltd
14 March 20x8

Verification of Liabilities
A balance sheet will contain many liabilities grouped under various headings. The headings may include:
Non Current Liabilities 
 Bank loans
Current Liabilities 
 Trade creditors 
 Accrued expenses 

 Unearned incomes 
 Taxation payable 
 Provision for losses
The auditors’ duty is four-fold: 
1. To verify the existence of liabilities shown in the balance sheet
2. To verify the correctness of the money amount of such liabilities
3. To verify the appropriateness of the description given in the accounts and the adequacy of disclosure
4. To verify that all existing liabilities are actually included in the accounts 

Verification methods:
It is not possible to detail the procedures for verifying all possible liabilities. However, some general principles
can be discerned, and these should be applied according to the particular set of circumstances met with in
practice or in an examination. These are: 
a. Schedule. Request or make a schedule for each liability or class of liabilities. This should show the
make up of the liability with the opening balance, if any, all changes, and the closing balance. 
b. Cut-off. Verify cut-off. For example a trade creditor should hot be included unless the goods were
acquired before the year end. 
c. Reasonableness. Consider the reasonableness of the liability. Are there circumstances which ought to
excite suspicion? 
d. Internal control. Determine, evaluate and test internal control procedures. This is particularly important
for trade creditors. 
e. Previous date clearance. Consider the liabilities at the previous accounting date. Have they all been
f. Terms and conditions, this applies principally to loans. The auditor should determine that all terms
and conditions agreed when accepting a loan have been complied with. In recent years many loan
deeds have contained undertakings by the company borrowing the money that it will keep a minimum
proportion of equity (ordinary share capital and reserves) in its total capital (equity and loans). Breach
of this agreement which has occurred frequently in property companies can lead to the appointment
of a receiver. 
g. Authority. The authority for all liabilities should be sought. This will be found in the company
minutes or directors' minutes and for some items the authority of the Memorandum and Articles may
be needed. 
h. Description. The auditor must see that the description in the accounts of each liability is adequate.
i. Documents. The auditor must examine all relevant documents. These will include invoices, 
correspondence, debenture deeds etc., according to the type of liability.
j. Security. Some liabilities are secured in various ways, usually by fixed or floating charges. The auditor 
must enquire into these and ensure that they have been registered. The Companies Act requires, for
secured liabilities, that an indication of the general nature of the security be given and also the
aggregate amount of debts included under the item covered by the security. 
k. Vouching. The creation of each liability should be vouched, for example the receipt of a loan.
l. Accounting policies. The auditor must satisfy himself that appropriated accounting policies have been 
adopted and applied consistently.
m. Letter of representation. This has been discussed in detail.
n. Interest and other ancillary evidence. The evidence of loans tends to be evidenced by interest 
payments and other activities which stem from the existence of the loan.
o. Disclosure. All matters which need to be known to receive a true and fair view from the accounts 
must be disclosed. The Companies Acts provisions must be complied with
p. External verification. With many liabilities it is possible to verify the liability directly with the 
creditor. This action will be taken with short term loan creditors, bank over drafts and, by a similar
technique to that used with debtors, the trade creditors, 
q. Materiality. Materiality comes into all accounting and auditing decisions. 
r. Post-Balance sheet events. These are probably more important in this area than in any other. It is 
an independent topic with its details. To understand it the accounting knowledge of “Events
occurring after the Balance Sheet Date - IAS 10” is must.  
s. Accounting Standards. Liabilities must be accounted for in accordance with the accounting standards. 

t. Risk. Assess the risk of misstatement.
Students may well remember these mnemonically. For any given liability all of them will not be required, but
mentally going through them should be an excellent guide to what needs to be done.

Inclusion of all liabilities (There is no liability remained unrecorded)
It is not enough for the auditor to be satisfied that all the liabilities recorded in the books are correct and are
incorporated in the Final Accounts. He must also be satisfied that no other liabilities exist which are not, for
various reasons, in the books and the accounts. Examples of such unrecorded liabilities are: 
a. Claims by employees for injury. Note that these should be covered by insurance under the Employers
Liability (Compulsory Insurance). 
b. Claims by ex employees for unfair dismissal.
c. Contributions to superannuation schemes.
d. Unfunded pension liabilities. A company may have a liability to pay past or present employees a 
pension in respect of past service and have no funds separated out for this purpose.
e. Liability to 'top-up' pension schemes. When money has been put into separate trusts to pay pensions, 
inflation has often meant that the amount is insufficient and the company may have to implement
Clauses in the scheme whereby they have to put in extra money which could run into millions of
f.  Bonuses under profit sharing arrangements.
g. Returnable packages and containers.
h. Value added and other tax liabilities. The auditor's special knowledge of tax may lead him to suspect a 
liability of which the directors are blissfully ignorant.
i. Claims under warranties and guarantees.  
j. Liabilities on debts which have been factored with recourse. To explain: A owes B Rs. 50. B sells 
(factors) the debt to C for Rs. 45. Thus B has no debt any more but Rs. 45 in the bank. A fails to pay
C. C can claim Rs. 50 from B (he has recourse). 
k. Bills receivable discounted (a special case of j above).
l. Pending law suits.  

It is important that the auditor appreciates that such liabilities can exist. He also has a positive obligation to
take reasonable steps to unearth them.
The actions he would take would include: 

a. Enquiry of the directors and other officers.  
b. Obtain a letter of representation - see later in the chapter.
c. Examination of post balance sheet events. This will include an inspection of the purchase invoices 
and the cash book after date.  
d. Examination of minutes where the existence of unrecorded liabilities may be mentioned. 
e. A review of the working papers and previous years' working papers
f. An awareness of the possibilities at all times when conducting the audit 


Equity consists of share capital and reserves. This part of the balance sheet represents interest of the owners in
net assets of the entity.
To verify the owners’ equity the auditor verifies following aspects: 
 Share capital is properly classified and described in the accounts 
 Movement in share capital is properly authorized and correctly presented 
 Reserves are properly classified and presented 
 Movements in reserves are properly authorized

Verification Methods
Share capital is properly classified and described in the accounts in accordance with the Companies
Ordinance, 1984 
1. Check disclosure using Company Accounts Checklist.
2. Agree authorized capital with memorandum of association.
3. Agree issued capital with form A, or obtain certificate from registrar.
4. Obtain list of shareholders. 
Movement in share capital is properly authorized and correctly shown and described in accordance
with the Companies Ordinance, 1984 
1. Ensure shareholders’ pre-emption rights have been respected.
2. Check that directors were authorized to allot shares.
3. Ensure proper authorization for share redemption.
4. Check authority for share capital reductions.
5. Agree all movements to statement in lieu of prospectus, board minutes, memorandum and articles of 
6. Consider special rules for allotments of public company shares.
7. Test allotments with supporting evidence and trace entries in register.
8. Test payments with supporting evidence and trace entries in register.
9. Check additions to allotment lists and cash records and agree totals to recorded movements.
10. Ensure correct treatment of share premiums.
11. Vouch issue expenses. 
Reserves are properly classified and described in the accounts in accordance with the Companies
Ordinance, 1984 
1. Ensure disclosure complies with Companies Ordinance, 1984.
2. Ensure whether it is clear, which reserves are distributable. 
Movements in reserves are properly authorized and currently shown and described in accordance
with the Companies Ordinance, 1984 
1. Check movements to minutes of Board’s meeting.
2. Check movements do not contravene statutory restrictions and articles of association.
3. Ensure disclosure of movements and related tax treatment. 

Lesson 35

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