11th Session Summary of Auditing 2 Fazlan Muallif and Rexy Dwi Putra

Final Work - Specific Problems

1. Auditing Accounting Estimates

It is widely understood that financial statement generally cannot be 100 % correct merely because
they contain estimations, such as : depreciaton expense ; accrued expense ; inventory provisions ;
bad debt provisions ; warranty provisionsm; deferred tax ; losses on construction contract in
progress.
The objective of this is to ensure that the auditor obtains sufficient appropriate audit evidence to
ensure that the accounting estimates and fair value accounting estimates are reasonable as well as
ensuring that the related disclosure notes in the financial statements are adequate (ISA 540.6).
Estimations of financial statement amounts increase the risk of material misstatement because of
the uncertainty surrounding accounting estimates. The auditors should also use significant
judgement when auditing accounting estimates because evidence relating to the accounting
estimates is generally less than conclusive.
At The Planning Stage
The auditors needs to understands the nature of the accounting estimates and assess its
susceptibility for material misstatement. In assessing the susceptibility for material misstatement,
the auditor will evaluate the degree of uncertainty associated with the estimation.
Review and Testing Process
Auditors can carry out a wide variety of testing and reviews. Note, however that each audit may
require different processes to be used in reviewing and testing accounting estimates and some
auditors may well have encountered different requirements, which need different levels of testing
during an audit.
During the audit of accounting estimates, the auditor needs to consider whether the financial
reporting framework adopted by the audit client is relevant to the accounting estimate being used.

2. Auditing Fair Value Measurement and Disclosures

The objective of this is to provide guidance for auditors on their responsibilities in terms of
auditing fair value measurements and their disclosure within the financial statements, in particular
the measurement, presentation and disclosure of material assets and liabilities as well as specific
components of equity which are presented, or disclosed, at fair value within the financial statement
(ISA 540).
The auditor shall evaluate whether the fair value measurements and disclosures within the financial
statement accord with the financial reporting framework adopted by entity. This enables the
auditor to confirm that the accounting and disclosure for assets and liabilities carried at fair value
is appropriate in the circumstances.
11th Session Summary of Auditing 2 Fazlan Muallif and Rexy Dwi Putra

Audit Procedures
The auditor must design and perform further audit procedures which are responsive to the assessed
levels of risk of material misstatement of assertions in relation to entity’s fair value measurement
and disclosures.
Undoubtedly, where active market prices are available, these prices could well be the best audit
evidence corroborating the fair value. The reality, however is tha some fair value measurements
are more complex than others, particularly those without published prices and in some cases the
auditor may consider it appropriate to engage an auditor’s expert
Examples of such procedures to gain an understanding of entity’s process for determining fair
value are : External Confirmation ; Fair Value Measurement ; Inspection ; Price Quotation ;
Identification of Risk ; Significant Assumptions
Fair Value Disclosures
The auditor shall evaluate whether the disclosures about fair values made by the entity are in
accordance with the financial reporting framework. In particular, the auditor will ensure that :
• Valuation principles are appropriate under the entity’s financial reporting framework;
• The valuation principles have been consistenly applied;
• The method of estimation ang significant assumptions used in arriving at fair value
measurement has been adequately disclosed;
• Any other disclosures required under the applicable financial reporting framework have been
adequately disclosured.

3. Inventories
Inherent risks affecting inventories
• Change in demand for company products;
• Production levels may be changed ‘normal’ levels;
• Defects in product lines and Inventories prone to theft;
• Cost allocations difficult in complex production process;
• Cost allocations arbitrary in joint product situation;
• Significant variances from standard costs and Increased competition;
• Complex calculation of overheads and Unreliable inventory records;
• Inventories at locations not of the organization and Poor physical controls;
• Lack of independence and experience of inventory count staff;
• Degree to which inventory levels fluctuate;
• Inventories requiring special procedures at count.
Controls to reduce the impact of inherent risk affecting inventories
• Periodic inventory counts often necessary to establish inventory quantities, condition and
ownership and the accuracy of inventory records, if any.
11th Session Summary of Auditing 2 Fazlan Muallif and Rexy Dwi Putra

• Apart from a satisfactory control environment, expect controls in the following areas:
Acquisitions of inventories ; Safeguarding inventories ; Determining existence, condition and
ownership at period-end dates ; Valuation of inventories.
The inventories figure in the financial statements bears direct relationships to other figures,
such as: Inventories to sales or cost of sales ; Raw material inventories to purchases ; Impact
on gross profit % ; Impact on current ratio.
Valuation of inventories
• The basic principle – lower of cost and net realizable value;
• Controls to ensure the costing and other records are reliable and produce inventory values on a
consistent basis;
• If standard costs are used to value – important control is analysis of variances and adjustment
of standards.
Other matters affecting inventories
• Disclosure of the effect of changes in basis of valuation;
• Have all calculations affecting inventory valuation been properly made?;
• Can the inventories be freely disposed of by the company?.

4. Valuation of Construction Contracts

• Audit objective one: costs incurred to date are genuine, accurate and complete;
• Audit objective two: stages of completion and costs of such stages have been properly
determined;
• Audit objective three: invoices issued to customers in respect of construction contracts are
properly calculated in accordance with contract and are in respect of all stages completed
certified by the surveyor;
• Audit objective four: cash received from clients is genuine, complete and accurate. In
particular, cash received has been properly allocated to contracts;
• Audit objective five: the estimated total costs are genuine, accurate and complete;
• Audit objective six: contract prices are genuine, accurate and complete;
• Audit objective seven: when attributable profits on contracts are taken up in the profit and loss
account, the contract is sufficiently complete to give adequate assurance that the outcome of the
contract is certain;
• Audit objective eight: the profitability of different stages of the contract has been properly
determined;
• Audit objective nine: the method employed in taking up profits is comparable with prior years,
unless the effect of any change is disclosed and is also appropriate.