Audit of Items of Financial Statements
Domain 5 applies evidence concepts to specific line items, where cut-off, valuation and disclosure errors actually occur.
Revenue and receivables
For revenue, test occurrence and cut-off around the year end, read contracts for performance obligations, and check credit notes and returns after the year end. For receivables, review the ageing, test expected credit loss assumptions, and confirm large balances.
Inventory
Existence is tested by attending physical verification under SA 501: observing the count, checking for slow-moving or damaged goods, and testing both sheet-to-floor and floor-to-sheet direction. Valuation is at lower of cost and net realisable value, with overhead absorption and abnormal wastage considered.
PPE, borrowings and provisions
For PPE, verify title deeds, check capitalisation of directly attributable cost, test depreciation rates and useful lives, and review capital work in progress for amounts that should be capitalised or impaired. For borrowings, check sanction letters, security created, covenant compliance and current/non-current classification. For provisions, apply SA 540 and the applicable reporting standard, with legal confirmations for litigation.
Worked example
Goods costing 20 lakh are dispatched on 28 March on a sale-or-return basis and recorded as sales. Reasoning: in a sale-or-return arrangement control does not pass with dispatch, so revenue recognition is premature. The auditor should examine the arrangement and subsequent returns, reverse the sale and the related receivable, and restore inventory.
Traps
- Accepting a despatch note as proof of sale when terms are FOB destination or on approval.
- Testing inventory at cost only and ignoring net realisable value.
- Allowing overheads unrelated to production into inventory cost.
- Missing unrecorded liabilities by testing payments only after the year end.