Financial Statements Assertions

The objective of audit testing is to assist the auditor in coming to a conclusion as to whether the financial statements are free from material misstatement.

However, the auditor does not simply design tests with the broad objective to identify material misstatement. This is a difficult conclusion to reach and can only be based upon a series of detailed tests, each designed with a specific testing objective relating to certain areas of the financial statements.

Illustration

For example: auditors have to assess whether inventory balances are free from material misstatement. Unfortunately, there are many ways inventory could be misstated:

• items could be missed out of inventory;
• items from the next accounting period could be accidentally included;
• it might not be valued at the lower of cost and net realisable value;
• damaged or obsolete stock might not be identified;
• purchase cost may not be recorded accurately; or
• the stock count may not be performed thoroughly.

Each of these concerns could result in misstatement, which ultimately could (alone or in aggregate) be material.

For this reason auditors have to perform a range of tests on the significant classes of transaction, account balances and disclosures to be reasonably sure that they are not misstated. These tests focus on what are known as financial statements assertions:

The assertions

Occurrence

Completeness

Have all transactions, assets, liabilities and equity interests been recorded that should have been recorded?

Accuracy

Have amounts, data and other information been recorded and disclosed appropriately?

Cut-off

Have transactions and events been recorded in the correct accounting period?

Classification and understandability

Have transactions and events been: recorded in the proper accounts; and described and disclosed clearly?

Existence

Do assets, liabilities and equity interests exist?

Rights and obligations

Does the entity hold or control the rights to assets and are liabilities the obligations of the entity?

Valuation and allocation

Are assets, liabilities and equity interests included in the financial statements at appropriate values?

Linking assertions to tests

When the auditor designs further audit procedures they must ensure that they test a range of the assertions listed. For transactions (i.e. incomes and expenses recorded in the income statement) the auditor should test:

• occurrence;
• completeness;
• accuracy;
• cut-off; and
• classification

For accounts balances (i.e. those balances recorded on the statement of financial position) the auditor should test:

• existence;
• rights and obligations;
• completeness; and
• valuation and allocation.

Whilst the testing of accounts balances and transactions will probably be the focus of the audit, the auditor must also design tests to ensure that transactions, balances and other relevant information/matters are appropriately disclosed in the financial statements. Assertions relevant to the disclosures are:

• occurrence;
• rights and obligations;
• completeness;
• classification and understandability; and
• accuracy and valuation.

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