Chapter 12

Final work: general principles,
analytical review of financial

statements, fixed assets
and debtors
Chapter 12
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LEARNING OBJECTIVES
After studying this chapter you should be

able to:
Explain the importance of planning the year-

end examination on the basis of interim work
and other information about the organization.
Describe the kind of work carried out on or
near the balance sheet date.
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LEARNING OBJECTIVES CONT'D
Show how audit techniques discussed earlier

in the book can be applied during the final
work on selected assets and related profit and
loss account headings.
Describe specific matters, including risk
assessments, considered in audit of selected
account headings, particularly fixed assets,
trade debtors and related profit and loss
account positions.
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LEARNING OBJECTIVES CONT'D
Explain why the auditor analyses financial

statements before and after performing
detailed audit work.
Describe the techniques employed by the
auditor in analysing financial statements.
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KEY POINTS p.424
Pre-final work
Discussions are held with management near the
year-end to ensure that preparation of financial
statements runs smoothly and timetables are met.
Auditors maintain regular contact with management
to detect problems early on in the process.
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KEY POINTS pp.424425
Potentially problematic areas include:
(a) known problems;
(b) stocktaking instructions;
(c) timetable for preparation of year-end financial
statements;
(d) circularizations;
(e) requirements of accounting and reporting
standards;
(f) new legislation;
(g) requirements of auditing standards.
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Balance sheet date work.

Typical audit work includes:
(a) bank confirmations;
(b) stock count observation;
(c) stages of completion of long-term
contracts/assets in course of construction;
(d) letters to other professionals.
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KEY POINTS p.426
Some time elapses between interim and final

examinations and auditors should ascertain
whether conclusions formed earlier are still valid
and whether systems operated as expected
during the whole year
This is know as bridging work.
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Analytical procedures.
ASB has adopted a balance sheet approach when
defining assets and liabilities and less attention is
paid to matching and accruals and to the profit
and loss account. It may mean that it becomes
more difficult to interpret profit and loss account
and income/expense headings.
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KEY POINTS p.429
The search for audit evidence is conducted on a

global and detailed basis and within a clearly
understood risk context.
Analytical review is useful when reviewing the
financial statements taken as a whole at the
conclusion of the audit.
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KEY POINTS p.429 CONT'D
Specifically, auditors determine whether:
(a) financial statements have been prepared using
consistent and appropriate accounting principles;
(b) information published with the financial statements
is compatible with them;
(c) presentation and disclosure are as required by law
and by regulatory bodies and achieve truth and
fairness;
(d) conclusions drawn from tests and overall review of
the financial statements enable an opinion to be
formed.
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KEY POINTS p.430
Auditors use ratio analysis and other interpretative

tools. Significant changes in figures revealed by
analytical review may result from:
(a) errors;
(b) changes in accounting practice;
(c) changes in management policy;
(d) changes in general commercial factors;
(e) changes in commercial factors affecting the
client only;
(f) fraud.
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ACTIVITY 12.1
Examine the draft financial statements of Kothari

Limited and, without calculating any ratios, note
matters of significance in the context of planning
the final examination.
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KEY POINTS p.432
In the examination room the best approach is:

(a) look at the figures broadly, before calculating
ratios;
(b) calculate selected ratios to confirm initial
impression;
(c) remember many ratios are interrelated;
(d) analysis of financial statements directs audit
effort.
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ACTIVITY 12.2
Now that you have obtained a global view, select

ratios that would support or refute the above
observations. Do not overdo it. Remember that
you wish to arm yourself with relevant
information before you go to see the chief
accountant.
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KEY POINTS p.434
Ratio analysis can be useful, but must be handled

with care as ratios are meaningless unless
compared with other ratios.
Auditors should ensure industry statistics have
been prepared in the same way as ratios used for
the company and be aware of special measures of
success or performance indicators used in a
particular industry.
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Other analytical tools include:

(a) graphs;
(b) regression analysis and multiple regression
analysis;
(c) Z-scores.
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ACTIVITY 12.3
Review the financial statements of Art Aid Ltd and,

using a risk-based approach, show with reasons
why you would wish to pay particular attention to:
(a) liquidity and gearing;

(b) high stock levels;
(c) gallery results;
(d) treatment of the work of local artists displayed
in the shop and the commission paid by them.
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ACTIVITY 12.3 CONT'D
You may consider matters other than those in

the financial statements, and ask yourself what
additional information you would like to have.
Suggest substantive procedures to satisfy

yourself that management assertions about the
above areas are valid in the context of the
financial statements.
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Remember that audit problems in one area may

be linked to those in other areas, so look at the
figures objectively and try to identify the real
concerns in this particular organization.
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KEY POINTS p.440
Accounting standards are designed to aid the

preparation of financial statements that give a true
and fair view.
Members of accounting bodies acting as auditors
or reporting accountants should justify significant
departures to the extent that their concurrence
with the departures is stated or implied.
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Financial statement assertions in respect of assets,

claims against assets, and related revenues and
costs are grouped under the headings
genuine
accurate
complete
prompting questions about existence, condition,
ownership, valuation and disclosure/presentation.
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KEY POINTS p.448
Tangible fixed assets

These vary in nature within companies and
between industries.
Inherent risk factors include:
(a) technological changes;
(b) closure of part of business;
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(c) difficulties in making estimates of useful lives;

(d) revaluation of fixed assets;
(e) existence of significant idle fixed assets;
(f) significant fixed assets in course of construction;
(g) own construction of fixed assets;
(h) moveable, high value assets.
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ACTIVITY 12.4
Explain why capitalization of own costs of

construction of tangible fixed assets might be
regarded as an inherent risk factor.
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KEY POINTS p.449
Apart from a satisfactory control environment,
specific controls are necessary to minimise control
risk over:
acquisitions, revaluation, impairment;
safeguarding;
disposals;
maintenance, insurance;
authorization of depreciation charges and
accumulations.
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Main control documents for acquisitions are fixed

assets budgets long, medium and short term.
The main accounting record for fixed assets is the
fixed assets register. To be a good control
document it should be held by persons independent
of those using and having custody of the fixed
assets, and be compared periodically with physical
assets and vice versa.
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KEY POINTS p.450
Using recorded details, fixed assets should be

reconciled by the company at least annually to
cost/valuation, accumulated depreciation and
depreciation charge figures in the financial
statements.
If a fixed assets register is not kept or the register
is found to be subject to error, control risk will be
increased and auditors may have to extend
substantive tests of detail.
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KEY POINTS p.451
Proceeds of sale of fixed assets may be

misappropriated if controls are not in place.
Disposals should be authorized in writing by
individuals with appropriate authority after careful
assessment of continuing value, with directors to
issue guidelines for making assessments.
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ACTIVITY 12.5
Clatto plc has a subsidiary whose draft financial

statements at 31 December 2007 show the
following picture of its tangible and intangible
assets:

Goodwill 1,000,000
Patents 150,000
Tangible fixed assets 2,000,000
____________
3,150,000
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During the current financial year a competitor

introduced a new improved product onto the
market, and the company suffered its first loss in
ten years. Average annual operating profits in the
ten years to 31 December 2006 were
2,500,000, but in the year to 31 December 2007
the draft financial statements show an operating
loss of 1,100,000.
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Explain how you would address the problems

facing the company from an audit point of view.
You may assume that the companys going-
concern status is not at risk. Consider the
intangible as well as tangible assets.
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ACTIVITY 12.6
Carry out an analytical review of the information

in Case study 12.3 and prepare a working paper
in which you list (with reasons) the matters that
will need further explanations from management.
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Analytical procedures on fixed assets might be

directed to:
significant additions and disposals;
profits/losses on disposal;
revaluations;
significant repairs;
maintenance charges.
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KEY POINTS p.455
On revaluation of fixed assets, financial statement

assertions include:
Genuine: revaluation has taken into account real
conditions; selected basis is appropriate;
Accurate: calculation of current values
appropriately reflects underlying value in
accordance with relevant accounting principles;
Complete: all fixed assets in a particular class
have been revalued.
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ACTIVITY 12.7
We have not referred to assertions respecting

revaluation of fixed assets. Suggest suitable
assertions under genuine, accurate and
complete headings. You may refer to IAS 16 and
FRS 15.
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Substantive procedures include that the valuer is

properly qualified and that the valuers scope of
work is appropriate, including:
(a) objectives and scope;
(b) clear statement of the matters to examine;
(c) why work is being carried out;
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KEY POINTS pp.457458 CONT'D
(d) information provided to the valuer, and its

reliability (from local planning and similar
authorities; and from client officials and solicitors);
(e) assumptions and methods used;
(f) timing of valuation.
A second valuation may be appropriate if

significant.
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KEY POINTS p.458
For disposals of fixed assets, determine the
reasons if significant and whether an impairment
review of the remaining assets is necessary.
Substantive procedures include:
(1) check number sequence of disposal approvals
and to the fixed assets register;
(2) select random sample of approvals and check
authorization signature and trace to sales
despatch notes.
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KEY POINTS p.462
Depreciation: audit work on depreciation is closely

allied to work on the fixed assets.
Specific matters of interest are:
useful economic lives and appropriateness of
depreciation method;
residual values;
depreciation on revalued fixed assets.
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Trade debtors
Trade debtors are normally classified as current
assets. It is important to determine the point at
which the property in goods is transferred or service
performed. Sales of goods and services cause
trade debtors to come into existence or increase
cash balances, so audit work on sales cannot be
divorced from work on the assets accounts.
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KEY POINTS p.464
The auditor would expect to see a satisfactory

control environment and control over:
(1) creation and clearance of trade debtors
balances;
(2) safeguarding of trade debtors.
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Important elements when safeguarding trade
debtors are as follows:
(a) the rapid billing of customers;
(b) regular preparation of statements and reminder
letters;
(c) offer of cash discounts;
(d) approval of entries reducing the stated amount
of debtors balances,
(e) ageing statement;
(f) credit limits.
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ACTIVITY 12.8
Review the figures for Sterndales sales and

debtors and prepare a working paper showing:
(a) additional calculations you would make in your

analysis of the companys sales and debtors
(b) further information you would obtain from
management to aid your conclusions on the
accuracy and completeness of sales and
debtors at 30 November 2007.
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Substantive approaches cover:
(a) creation of trade debtors balances;
(b) proving trade debtors are genuine, accurate
and complete;
(c) proving reasonable relationships between trade
debtors/sales and other figures in the financial
statements;
(d) checking cut-off;
(e) proving clearing entries are genuine, accurate
and complete, especially write-offs of balances;
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ACTIVITY 12.9
You already know a lot about the control of cash

receipts from debtors in Horton Ltd. Assume that
Horton keeps its debtors ledger on an open items
computer system and that inputs to the cash
receipts updating run are drawn from entries in the
cash receipts book. You will remember that:
(a) there is tight control over this book, which is
signed by two members of the accounting
department staff independent of the cashier and
the person holding the debtors ledger;
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(b) an accounts department member (not cashier)
periodically checks the cash received book with
the cash book and bank paying-in book and,
monthly, the cashier reconciles cash book and
bank statement balances, and the reconciliation
is checked and initialled by the chief accountant.
You have been asked to find evidence to prove that
cash receipts have been properly entered in the
cash records and the debtors ledger accounts.
Suggest appropriate substantive procedures.
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(f) proving accounting methods for determining

sales and related debtors are acceptable and
consistent;
(g) proving that debtors represent customers who
exist and amounts owed to the company;
(h) proving debtors balances are collectable;
(i) checking proper disclosure of debtors
receivable in the short, medium and long term,
and those subject to encumbrances.
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KEY POINTS p.474
Two useful tests are to

(1) circularize debtors
(2) to test after-date receipts
Testing after-date receipts may be more useful
than circularization as replies from debtors may
not always be trustworthy and debtors may not
even reply.
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ACTIVITY 12.10
Assume that the auditor circularized 60 debtors

of Sterndale. Do you think that this might be too
many? What would cause you to think that a
lower number of debtors might be selected say
30, or even 10?
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KEY POINTS p.475
Factoring means that ownership passes to third

party, even though the initial sales transaction had
been with the company.
The auditor would examine the factoring
agreement, test the system for recording factored
debtors and obtain confirmation from the third
party of debtors balances transferred.
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ACTIVITY 12.11
Review the extract from the ageing statement of

Sterndale plc and list the matters you would raise
with management. You are interested in ensuring
that the debtors have the realizable value stated
in the financial statements, taking into account
the provision for bad and doubtful debts.
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CHAPTER SUMMARY
This chapter has discussed:

The pre-final planning process;
Typical audit work carried out by the auditor at or
near to the balance sheet date;
The role of analytical procedures and
approaches to analytical review;
Ratio analysis as the main analysis tool;
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CHAPTER SUMMARY CONT'D
The need to analyse in detail as well as in
global terms;
The fact that auditors are insiders in terms of
the information they have the right to obtain and
that more detailed information is thus available
to them than would be to investment analysts;
Factors of importance to the auditor, such as
fixed assets and trade debtors and related
income and expense;
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CHAPTER SUMMARY CONT'D
The particular need to determine if figures in the

financial statements are genuine, accurate and
complete;
Tests of existence, condition, ownership,
valuation and disclosure.
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FURTHER READING
Higson, A. (1991) The rise of analytical auditing

procedures, in Sherer, M. and Turley, S. (eds)
Current Issues In Auditing (2nd edn), London: Paul
Chapman Publishing.
Higson, A. (1997) Developments in audit
approaches: From audit efficiency to audit
effectiveness, in Sherer, M. and Turley, S. (eds)
Current Issues In Auditing (3rd edn), London: Paul
Chapman Publishing.
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FURTHER READING CONT'D
ISAs that you should read in conjunction with this

chapter are:
ISA 505 External confirmations
ISA 520 Analytical procedures
ISA 620 Using the work of an expert.
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Chapter 12

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Final work: general principles,

analytical review of financial

After studying this chapter you should be

Explain the importance of planning the year-

Show how audit techniques discussed earlier

Explain why the auditor analyses financial

Balance sheet date work.

Some time elapses between interim and final

The search for audit evidence is conducted on a

Auditors use ratio analysis and other interpretative

Examine the draft financial statements of Kothari

In the examination room the best approach is:

Now that you have obtained a global view, select

Ratio analysis can be useful, but must be handled

Other analytical tools include:

Review the financial statements of Art Aid Ltd and,

(a) liquidity and gearing;

You may consider matters other than those in

Suggest substantive procedures to satisfy

Remember that audit problems in one area may

Accounting standards are designed to aid the

Financial statement assertions in respect of assets,

Tangible fixed assets

(c) difficulties in making estimates of useful lives;

Explain why capitalization of own costs of

Main control documents for acquisitions are fixed

Using recorded details, fixed assets should be

Proceeds of sale of fixed assets may be

Clatto plc has a subsidiary whose draft financial

During the current financial year a competitor

Explain how you would address the problems

Carry out an analytical review of the information

Analytical procedures on fixed assets might be

On revaluation of fixed assets, financial statement

We have not referred to assertions respecting

Substantive procedures include that the valuer is

(d) information provided to the valuer, and its

A second valuation may be appropriate if

Depreciation: audit work on depreciation is closely

The auditor would expect to see a satisfactory

Review the figures for Sterndales sales and

(a) additional calculations you would make in your

You already know a lot about the control of cash

(f) proving accounting methods for determining

Two useful tests are to

Assume that the auditor circularized 60 debtors

Factoring means that ownership passes to third

Review the extract from the ageing statement of

This chapter has discussed:

The particular need to determine if figures in the

Higson, A. (1991) The rise of analytical auditing

ISAs that you should read in conjunction with this

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