AAA – Audit of Historical Financial

Information
Accounting Standards – Part 1

Although this is an auditing paper, we saw in the last few sessions the importance of accounting standards
knowledge. The summary that follows should remind students of the key accounting issues that individuals may
need to explore in more detail if it is felt that there is a significant gap in their accounting knowledge.

IAS 2 – INVENTORIES:

Inventory should be valued at the lower of cost and net realisable value. The major audit risk is an overstatement
because net realisable is lower but the inventory is still being recorded at cost. Major sources of evidence are the
cost components and the sales invoices.

IAS 7 – STATEMENTS OF CASH FLOW:

Students need to be familiar with both the direct and indirect methods of preparation and know that a change from
one to the other is a change in accounting policy.

IAS 8 – ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND

ERRORS:

Learn the difference between a change in policy and a change in estimate. A policy change should be adjusted
retrospectively, whilst a change in estimate is dealt with prospectively.

IAS 10 – EVENTS AFTER THE REPORTING PERIOD:

 An adjusting event is where additional evidence comes to light regarding conditions that existed at the reporting
date.
 A non-adjusting event is where no pre-existing conditions exist.
The key audit work here would be done after the end of the year looking at cashbooks and correspondence for
large or unusual items.

IAS 37 – PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS:

Learn the 3 part definition of a provision:

1. Past event;
2. Likelihood of payment;
3. Reliable estimate available.

Audit work will concentrate on the existence of the past event such as court cases or industrial accidents.

IAS 36 – IMPAIRMENT:

An impairment occurs if the recoverable value of an asset falls below its carrying value. The recoverable amount
is the higher of the value in use and the net realisable value. Is it better to keep the asset and use it or sell it as
soon as possible?

Audit work would include inspection of the plant register to confirm the carrying value, third party valuations for net
realisable value and cash flow forecasts for estimated value in use.

IAS 20 – GOVERNMENT GRANTS:

 Capital grants are provided to help a company buy a specific item so the revenue should be spread over the
useful economic life of that item.
 Revenue grants are for immediate financial assistance so should be recognised as income straight away.

IFRS 16 LEASING

This is a new accounting standard that replaces IAS 17 and removes the distinction between Finance and
Operating leases.

 All lease agreements lasting for more than one year now result in a right of use asset being recognised in the
lessee’s financial statements.

 A corresponding liability should also be recognised.

 The subsequent asset / liability treatment is the same as it was under IAS 17.

 There is still a risk of misclassification because the standard is new and may not yet have been applied. Also
leases for less than a year should be treated as just rental expenses, no asset or liability recognised at all, and
 this may not have been done

Audit work should include inspection of the lease agreement to determine the lease length and the initial values
of both asset and liability.

IAS 40 – INVESTMENT PROPERTY:

Land and buildings held for investment potential or for their capital appreciation must not be depreciated. They
must be remeasured each year at fair value with gains and losses impacting upon profit. There is a significant risk
of misclassification as a tangible.

IAS 24 – RELATED PARTY TRANSACTIONS:

All related party transactions must be disclosed in a note to the financial statements. Audit work will include
inspection of share registers, board minutes and other general correspondence for evidence of personal
relationships.

IAS 33 – EARNINGS PER SHARE:

Both basic and fully diluted earnings per share calculations must be disclosed in the financial statements. So there
is an audit risk of non-disclosure.

IAS 21 – FOREIGN EXCHANGE:

 Individual foreign currency transactions are initially translated at the historic rate then monetary items are
retranslated at the closing rate at the year-end.
 Subsidiary results are translated at the yearend using the closing rate method -profit and loss items at average
rate and statement of financial position items at the closing rate.

The main audit risk is that the wrong translation rate is used.