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AAS 34
Audit Evidence - Additional
Considerations for Specific Items
The following is the text of the Auditing and Assurance Standard (AAS)
34, "Audit Evidence - Additional Considerations for Specific Items",
issued by the Council of the Institute of Chartered Accountants of India.
This Standard should be read in conjunction with the "Preface to the
Statements on Standard Auditing Practices", issued by the Institute.
Introduction
- The purpose of this Auditing and Assurance Standard is to establish
standards on the auditor's responsibilities, audit procedures and
provide additional guidance to that contained in Auditing and Assurance
Standard (AAS) 5, "Audit Evidence", with respect to certain specific
financial statement amounts and other disclosures. Application of the
standards and guidance provided in the AAS will assist the auditor in
obtaining audit evidence with respect to the specific financial
statement amounts and other disclosures. This AAS comprises the
following parts:
Part A: Attendance at Physical Inventory Counting
Part B: Inquiry Regarding Litigation and Claims
Part C: Valuation and Disclosure of Long-term Investments
Part D: Segment Information
Part A: Attendance at Physical Inventory Counting
- The auditor should perform audit procedures designed to obtain
sufficient appropriate audit evidence during his attendance at physical
inventory counting.
Definitions
- Definitions regarding "Inventory" are given in Accounting Standard
(AS) 2,Valuation of Inventories, issued by the Institute of Chartered
Accountants of India, and are adopted for the purposes of this AAS1.
- Physical verification of inventories is the responsibility of the
management of the entity. Management ordinarily establishes
procedures under which inventory is physically counted at least once in
a year (end of the year, generally, or as near the end of the year as
possible) to serve as a basis for preparation of the financial
statements or to ascertain the reliability of the perpetual inventory
system.
- When inventory is material to the financial statements, the
auditor should obtain sufficient appropriate audit evidence regarding
its existence and condition by attendance at physical inventory counting
unless impracticable, due to factors such as the nature and location of
the inventory. The attendance at such physical inventory counting
will enable the auditor to inspect the inventory, to observe compliance
with the operation of management's procedures for recording and
controlling the results of the count and to provide evidence as to the
reliability of management's procedures.
- If unable to attend the physical inventory count on the date
planned due to unforeseen circumstances, the auditor should take or
observe some physical counts on an alternative date and where necessary,
perform alternative audit procedures to assess whether the changes in
inventory between the date of physical count and the period end date are
correctly recorded.
- Where attendance at the physical inventory counting is
impracticable, the auditor should consider whether alternative
procedures provide sufficient appropriate audit evidence of existence
and condition of inventory to conclude that the auditor need not make
reference to a scope limitation. For example, the auditor should
examine a sample of documents evidencing the movement of inventory into
and out of stores shortly before and after the cut-off date, and verify
whether the inventory represented by those documents were included or
excluded, as appropriate during the inventory count.
- In planning attendance at the physical inventory count or the
alternative procedures, the auditor would consider the following:
- The nature of the accounting and internal control systems used
regarding inventory.
- Inherent, control and detection risks, and materiality related to
inventory.
- Whether adequate procedures are established and proper
instructions issued for physical inventory counting.
- The timing of the count.
- The locations at which inventory is held and its nature
- Whether an expert's assistance is needed.
When inventory is situated in several locations, the auditor would
consider at which locations attendance is appropriate, taking into
account the materiality of the inventory and the risk of material
misstatement and the assessment of inherent and control risk at
different locations.
- The auditor would review management's instructions regarding:
- The application of control procedures, for example, collection of
used stock-sheets, accounting for unused stock-sheets and count and
re-count procedures;
- Accurate identification of the stage of completion of work in
progress of slow moving, obsolete, damaged or rejected items of
inventory owned by a third party, for example, on consignment and
inventory in transit; and
- Appropriate arrangements made regarding the movement of inventory
between areas and the shipping and receipt of inventory before and
after the cut-off date.
- The auditor would also consider cut-off procedures including details
of the movement of inventory just prior to, during and after the count
to ensure that such movements are appropriately included and/or
excluded, as applicable from such inventory. For example,
- goods purchased but not received are included in the inventories:
and
- goods sold but not despatched are excluded from the inventories.
- When the quantities are to be determined by a physical inventory
count and the auditor attends such a count, or when the entity operates
a perpetual inventory system and the auditor attends a count one or more
times during the year, the auditor would ordinarily observe count
procedures and perform test counts.
- If the entity uses procedures to estimate the physical quantity,
such as estimating a coal pile, the auditor would need to be satisfied
regarding the reasonableness of those procedures.
- To obtain assurance that management's procedures are adequately
implemented, the auditor would observe physical verification procedures
performed by the employees and perform test counts. When performing
counts, the auditor would test both the completeness and the accuracy of
the count records by tracing items selected from those records to the
physical inventory sheets and items selected from the physical inventory
to the count records. Where tagging method of physical count of
inventory is used, the auditor should verify the tag reconciliation
prior to the counting or before finalizing the count. The auditor would
consider the extent to which copies of such count records need to be
retained for subsequent audit procedures testing and comparison.
- For practical reasons, the physical inventory count may be conducted
at a date other than period end. This will ordinarily be adequate for
audit purposes only when the control risk is assessed at less than high.
The auditor would assess whether, through the performance of appropriate
audit procedures, changes in inventory between the count date and period
end are correctly recorded.
- When the entity operates a perpetual inventory system, which is used
to determine the period end balance, the auditor would assess whether,
through the performance of additional procedures, the reasons for any
significant differences between the physical count and the perpetual
inventory records are understood and the records are properly adjusted.
- The auditor performs audit procedures over the final inventory
listing to assess whether it accurately reflects actual inventory
counts.
- When inventory is under the custody and control of a third party,
the auditor would ordinarily obtain direct confirmation from the third
party/arrange with the entity for sending requests for such confirmation
as to the quantities and condition of inventory held on behalf of the
entity. Further, depending on materiality of this inventory the auditor
would also consider the following:
- The conduct of the third party in the past with the entity and
independence of the third party.
- Observing, or arranging for another auditor to observe, the
physical inventory count.
- Obtaining another auditor's report on the adequacy of the third
party's accounting and internal control systems for ensuring that the
inventory is correctly counted and adequately safeguarded.
- Inspecting documentation regarding inventory held by third
parties, for example, warehouse receipts.
- Subsequent receipt of goods from third parties.
Management Representations
- The auditor should obtain a written representation from
management concerning :
(a) the completeness of information provided regarding the inventory;
and
(b) assurance with regard to adherence to laid down procedures for
physical inventory count.
Audit Conclusions and Reporting
- If the auditor is unable to obtain sufficient appropriate audit
evidence concerning the existence of inventory or adequacy of procedures
adopted by the management in respect of physical inventory count the
auditor should make a reference to a scope limitation in his audit
report. If the inventory is not disclosed appropriately in the financial
statements, the auditor should issue a qualified opinion.
Part B: Inquiry Regarding Litigation And Claims
Definitions
- (a) "Litigation" means a lawsuit or legal action including all
proceedings therein.
(b) "Claims" means a right to payment or right to an equitable remedy
for breach of performance.
- Litigation and claims involving an entity may have a material effect
on the financial statements and thus may be required to be disclosed
and/or provided for in the financial statements.
- The auditor should carry out audit procedures in order to become
aware of any litigation and claims involving the entity which may have a
material effect on the financial statements. Such procedures would
include the following:
- Make appropriate inquiries of management including obtaining
representations.
- Review board /committee minutes and correspondence with the
entity's lawyer.
- Examine legal and other relevant expense accounts.
- Use any information obtained regarding the entity's business
including information obtained from discussions with in-house legal
department, if any.
- When litigation or claims have been identified by the management or
when the auditor believes they may exist, and are likely to be material,
the auditor should seek direct communication with the entity's lawyers
and such other professionals to whom the entity engages for litigation
and claims. Such communication will assist in obtaining sufficient
appropriate audit evidence as to whether potentially material litigation
and claims are known and management's estimates of the financial
implications, including costs, are reliable.
- The letter seeking direct communication with the entity's lawyers
and such other professionals to whom the entity engages for litigation
and claims should be should be prepared by management. The auditor
should maintain control over the process of preparation and sending of
the letter. The letter should request the entity's lawyers and such
other professionals to whom the entity engages for litigation and claims
to communicate directly with the auditor. The letter would
ordinarily specify the following:
- A list of litigation and claims.
- Management's assessment of the outcome of the litigation or claim
and its estimate of the financial implications, including costs
involved.
- A request that the entity's lawyer confirm:
(i) the reasonableness of management's assessments;
(ii) provide the auditor with further information if the list is
considered to be incomplete or incorrect;
(iii) provide updated information as and when requested by the auditor
upto the date of the audit report; and
(iv) provide updates information as and when requested by the auditor
upto the date of the audit report.
- The auditor considers the status of legal matters up to the date of
the audit report. In some instances, the auditor may need to obtain
updated information from lawyers.
- In certain circumstances, for example, where the matter is complex
or there is disagreement between management and the entity's lawyers and
such other professionals to whom the entity engages for litigation and
claims, it may be necessary for the auditor to meet with the entity's
lawyers and such other professionals to whom the entity engages for
litigation and claims to discuss the likely outcome of litigation and
claims. Such meetings would take place with management's permission and,
preferably, with a representative of management in attendance.
- If management refuses to give the auditor permission to
communicate with the entity's lawyers, this would constitute a
limitation on the scope of the auditor's work that requires expression
of a qualified opinion or a disclaimer of opinion as the case may be.
Where a lawyer or a professional refuses to respond in an
appropriate manner and the auditor is unable to obtain sufficient
appropriate audit evidence by applying alternative procedures, the
auditor would consider whether there is a scope limitation which may
lead to a qualified opinion or a disclaimer of opinion.
Management Representations
- The auditor should obtain a written representation from
management concerning the completeness and adequacy of information
provided regarding the identification of litigation and claims,
estimates of financial implications, including costs, etc.
Part C: Valuation And Disclosure Of Long Term Investments
- The auditor should perform audit procedures designed to obtain
sufficient appropriate audit evidence for valuation and disclosure of
long term investments.
Definitions
- Definition regarding "Long Term Investments" is given in Accounting
Standard (AS)13, Accounting for Investments, issued by the Institute of
Chartered Accountants of India and is adopted for the purposes of this
AAS.2
- When long-term investments are material to the financial
statements, the auditor should obtain sufficient appropriate audit
evidence regarding their valuation and disclosure.
- Audit procedures regarding long-term investments ordinarily include
obtaining audit evidence with respect to their ownership and existence
as to whether the entity has the ability to continue to hold the
investments on a long term basis and discussing with management whether
the entity will continue to hold the investments as long-term
investments and obtaining written representations to that effect.
- Other procedures would ordinarily include:
(a) In the case of quoted securities, considering related financial
statements and other information, such as market quotations, which
provide an indication of value and comparing such values to the carrying
amount of the investments up to the date of the auditor's report.
(b) In case of unquoted securities, ascertaining the method adopted by
the entity for determining the value of such securities as at the year
end. The auditor should examine whether the method adopted by the entity
is one of the recognised methods of valuation of securities such as
Profit Earning Capacity Value method, break-up value method,
capitalization of yield method, yield to maturity method, etc.
(c) In the case of investments other than in the form of securities,
ensuring that the market value has been ascertained on the basis of
authentic market reports, and /or based on expert's opinion, if
warranted.
- If such values do not exceed the carrying amounts, the auditor would
consider whether a write-down is required. If there is an uncertainty as
to whether the carrying amount will be recovered, the auditor would
consider whether appropriate adjustments and/or disclosures have been
made.
Management Representations
- The auditor should obtain a written representation from
management concerning:
(a) The completeness of information provided regarding valuation and
disclosure of long term investments.
(b) The valuation of long term investments in the financial statements
including adequacy of provision for diminution in such values, wherever
required; and
(c) The intention of the management to continue to hold long-term
investments as long-term investments.
Audit Conclusions and Reporting
- If the auditor is unable to obtain sufficient appropriate audit
evidence concerning the existence, valuation of long term investments or
concludes that their disclosure in the financial statements is not
adequate, the auditor should express a qualified opinion or a disclaimer
of opinion in the audit report, as may be appropriate.
Part D: Segment Information
- The auditor should perform audit procedures designed to obtain
sufficient appropriate audit evidence for appropriate disclosure of
segment information.
Definitions
- "Segment Information" means the information to be disclosed in
respect of reportable segments as given in Accounting Standard (AS)17,
"Segment Reporting", issued by the Institute of Chartered Accountants of
India or as defined in the financial reporting framework applicable to
the entity.
- When segment information is material to the financial statements,
the auditor should obtain sufficient appropriate audit evidence
regarding its disclosure in accordance with the applicable identified
financial reporting framework.
- The auditor considers segment information in relation to the
financial statements taken as a whole, and is not required to apply
auditing procedures that would be necessary to express an opinion on the
segment information standing alone. Audit procedures regarding segment
information ordinarily consist of analytical procedures and other audit
tests appropriate in the circumstances.
- The auditor would discuss with management the methods used in
determining segment information, and consider whether such methods are
likely to result in disclosure in accordance with the applicable
financial reporting framework and test the application of such methods.
The auditor would consider sales, transfers and charges between
segments, elimination of inter-segment amounts, comparisons with budgets
and other expected results, for example, operating profits as a
percentage of sales, and the allocation of assets and costs among
segments including consistency with prior periods and the adequacy of
the disclosures with respect to inconsistencies.
Management Representations
- The auditor should obtain a written representation from
management concerning:
a) the completeness of information regarding segments and disclosure
thereof; and
b) appropriateness of the selected segments based on risks and returns;
and
c) the organizational structure of an enterprise and its internal
financial reporting system and any deviations therefrom.
Audit Conclusions and Reporting
- If the auditor is unable to obtain sufficient appropriate audit
evidence concerning segment information or concludes that their
disclosure in the financial statements is not adequate, the auditor
should express a qualified opinion or a disclaimer of opinion in the
audit report, as may be appropriate.
Effective Date
- This Auditing and Assurance Standard becomes operative for all
audits related to accounting periods beginning on or after 1st April,
2005.
Compatibility with the International Standard on Auditing (ISA) 501
The auditing standards established in this AAS are generally consistent
in all material respects with those set out in ISA 501, "Audit Evidence -
Additional Considerations for Specific Items" except the following:
- Due to practical reasons, paragraph 23 of the AAS requires that when
litigation or claims have been identified by the management or when the
auditor believes they may exist, and are likely to be material, the
auditor may seek direst communication with the entity's lawyers. The
auditor need not necessarily communicate with the entity's lawyers and
such other professionals to whom the entity engages for litigation and
claims involving the entity which may have a material effect on the
financial statements. The ISA on the other hand requires that the
auditor should communicate with the entity's lawyers to obtain
sufficient appropriate audit evidence as to whether potentially material
litigation and claims are known and management's estimates of the
financial implications, including costs, are reliable.
- Each part of the AAS contains the requirements related to obtaining
the management representations [see paragraphs 18, 28, 35 and 42]. There
is, however, no such requirement in the ISA.
[1]
Paragraph 3 of the Accounting Standard (AS) 2, Valuation of Inventories,
states as follows:
"3. The following terms are used in this Statement with the meanings
specified:
Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production
process or in the rendering of services."
[2]
Paragraph 3 of Accounting Standard (AS) 13, Accounting for Investments,
states as follows:
"3. The following terms are used in this Statement with the meanings
assigned:
A Current Investment is an investment that is by its nature readily
realizable and is intended to be held for not more than one year from the
date on which such investment is made.
A long term investment is an investment other than a current
investment."
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