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it's important for every business to generate revenue but what's also as equally important is to control the outflow of cash we have cash going out for things like buying supplies buying raw materials or inventory paying our employees so today i'm going to focus on auditing expenses you'll also know that i've looked at auditing employee entitlements so wages etc before and also accounts payable which is when we buy on credit and then we have those balances left to pay at the end of the period but today i'm looking at the expense lines the types of things that we're going to see on our income statement so let's get into it [Music] what's up whaddup fans welcome back to my regular subscribers hello to all those people out there um i see viewers in india in zimbabwe and all sorts of fantastic places so it's really great to have you back here on my channel to anyone who's new hi my name is amanda and i teach auditing at a major australian university to undergrads now today we're going to be looking at expenses and i'm not really going to talk about the process today because if you've gone back to my accounts payable one video there's a whole lot on the process to approve the purchase of something or the use of expenditure today we're just going to dig straight into the substantive testing rather than the testing around internal controls if you go back to the accounts payable video where i look at approvals purchase requests receiving reports and matching you'll see all of those typical controls around expenses today i'm focusing on just the substantive testing and of course we're going to look at some practical examples now when auditing expenses the thing that we're most concerned about is usually understatement all right so we're worried about understatement because companies are trying to make their profits look better and that could be to look better to the market for managers to achieve some sort of performance-based bonus then they're likely to understate expenses overstate revenues understand expenses so in terms of that understatement that could be done in a couple of different ways that could be by manipulating completeness by not actually reporting all of the expenses that come about or it could be by manipulating the accuracy of the transaction so by under reporting the amount for each transaction as it's being recorded now remember you need to think about your individual specific client or if you're in an exam the individual scenario if you're a company that is uh doing really well during the pandemic you might be actually trying to overstate your expenses so if you are receiving some form of government assistance that requires you to have lower profits then there may be some incentive to actually overstate oops overstate your expenses somewhat all right and remember there are expenses in lots of different types of areas so you need to look at your client and say okay what is more likely are they more likely to understate or overstate or you're not quite sure and you're going to potentially be looking for both now in terms of expenses there are lots of things that come under expenses so what is included all right i'm not going to include your inventory cost of goods sold type expenses here but remember we've got operating expenses so that could be things uh like electricity for the factory etc you're going to have sales and marketing expenses so that could be advertisements packaging all sorts of other things so in terms of looking at the expenses again i'm not going to identify any specific ones but the process for auditing them is all the same you've got sales and marketing you could have legal expenses all types of different things could come in here and it's going to be worth making sure that you select a sample of different expenses but also look at how what expenses are larger so one thing that you might want to do is also try and put all of your expenses in some sort of pie chart all right and that way you can find out ah okay if all of these expenses over here that i'm going to highlight in yellow so let's say all of that is operating well then you definitely want to make sure that your sample collects more operating expenses than anything else now if we look to this one over here this one might be sales and marketing all right and then over here you might have legal all right so i'm just guessing here but in this particular instance you'd want to spend more on your operating expenses and potentially legal expenses and then slightly less on your sales and marketing only because they tend to be a little bit smaller and you want to try and get as much coverage of your population as possible it's important to make sure that we analyze a mix of our expenses so that we know where there are larger expenses so obviously you can look here just on the general value you might also do something by analyzing the percentage change between years to see if anything is unusual and you might also even just scan through a whole list of all the expense accounts and the balances just to see if anything pops out at you you might notice that entertaining expenses are really really high but in the middle of covert 19 you can't really do any entertaining so that would be something to query so you know we're looking at it from an analytical perspective of the size and the percentage change you might do a scan to look for anything that qualitatively looks a little bit unusual um and then also you know if you're going to the client look around does you think oh okay this is a marketing firm why are they spend spending money on concrete or something that just doesn't make sense so it's about looking holistically at that particular issue now the next thing i'm going to do is i'm going to attack this problem or our task of designing procedures from the assertion perspective i always start with the assertion so let me write those down first [Music] okay so i have my assertions occurrence completeness accuracy cut off and classification remember these all come out of isa 315 in the appendices for some i think i want to say paragraph 100 a 198 i'll check and make sure i put it in the video to be sure but i need to always start with my assertions now remember i talked about the assertions that i thought might be at greatest risk of misstatement potentially if we're worried about understatement completeness and accuracy so in those instances there i might want to use more than one procedure that's always a possibility uh to help me identify potential misstatements so the first thing we're going to start with is occurrence did sales really occur now we know that we always want to start with vouching okay so starting at the end and working backwards so vouching a random sample of of expense journals expense i almost wrote sales journals there expense journal entries all right two and we probably want to see we probably want to see some sort of invoice from the supplier some sort of receiving report did we actually get the items or receive that particular service we want to also make sure that there's an approved purchase request all right so i've talked about the actual procedure i want to do i'm vouching i've talked about my sample i'm going to use a random sample of the journal entries and i'm going back to check those items so so in looking at those documents i need to be also a bit more specific so i'm going to vouch to those items ensure a transaction was real and prices and quantities were accurate well that's right correct all right so i want to make sure that there is that documentation now you notice that i've also said prices so where i said prices here that's also going to help me later on down here when i'm testing accuracy all right so i'm just checking those prices for now um and then i'm going to go into a little bit more depth so for occurrence we're not so worried about expenses unless potentially we think there's some sort of related party transaction scam going on but we should always still check occurrence now we're more worried about completeness all right did all of the expenses have they all been recorded are they trying to hide any by just not recording them so we know there for completeness we want to trace trace a and i'm here i'm using haphazard sample of purchase requests now you could also potentially say here approved purchase orders depends on the process in your company really that you're looking at a sample of purchase requests to receiving reports invoices from the supplier and journal entries all right because remember when the invoice is received when we receive the goods we should have that journal entry that says debit expense credit accounts payable you could also go one step further there and potentially also look at the payment process all right so was there a three-way match was there a payment to that particular supplier and you could do that as sort of a combined purchases or expenses and accounts payable testing so we want to make sure that that process is followed through the entire way so that uh all documents uh present and accounted for now during that process of checking the journal entries you might also decide that you're going to test classification so here we're going to write while testing completeness check that the journal entry is correct by matching the accounts used to the chart of accounts remember that the chart of accounts is the mega list of all of the accounts so make sure it's going to the right place so you're wanting to check that for electricity it's going debit electricity expense and it's not going to somewhere else entertaining marketing etc so you can do that there so you know a lot of these tests what might sound like a lot you're doing these tests in a combined fashion now if you're also worried about completeness but you think oh what if what if they've destroyed the purchase requests the other thing that you can do is examine a sample of bank statements and match payments to expenses or purchases just like you would use a subsequent cash payment test to help you identify any accounts payable that might not be recorded you can look at bank statements and try and match them back to expenses or purchases just to see if anything you know doesn't match up so do you have any expenses that don't link back to an expense account what were they for because just because people purchased items doesn't mean that they don't have to pay for them later so that's another way that we can do that so when it comes to accuracy what we need to do is we need to make sure that everything is recorded at the correct dollar value so remember up here when we looked at occurrence and we're going to make sure that the prices and the quantities are correct you could do that when you're tracing as well but let's write a procedure here while tracing and vouching recalculate the value or amount of the transactions all right so check quantity charged matches the quantity ordered oops let me try and shorten that quantity ordered price is as quoted so if we were quoted ten dollars per item then you know did we get charged ten dollars per item and recalculate the line items all right now let me just make some more room here so that i can put this down here let's put that there okay so here is an example of an invoice we've got the quantity we've got the item we got the price we've got the total so we bought five of item a and they were five dollars each so it should be 25 we bought ten of item b at seven dollars each that'll be 70 which gives me a total of 95. all right so that part where i've said okay what i'm going to do is i'm going to recalculate the line items that is over here and so we say 5 times 5 equals 25 so that's recalculating the line item now you might sometimes see this as like calculating the extension so it's really the extension of the line and checking the total sometimes can be called footing the total i tend to use just plain english here but if you're in a specific audit firm they might use some of these specific audit terms but i'm approaching this from the perspective of you don't know any of those uh specific pieces of terminology so recalculating the line item is looking at that individual line item so you're going to uh recalculate the line items and check the total of the order is correct okay now when it comes to doing that total i'm going to do this in a different highlight color here you're going to go okay 25 plus 70 does that equal the 95 now remember that if you're doing this while you're vouching or while you're tracing you're also going to be checking this to the journal entry so another thing that we can put in here but you're sort of going to do at the same time as testing occurrence and completeness is that you will also match the oh hang on rather than match let's say more accurately check that the expense total matches what is recorded in the journal entry now remember here you know we also did our cutoff test which talked about checking those debits and credits you could have a couple of different journal entry options here option one is going to be debit expense credit cash if that was paid for straight away or you could have debit expense credit some sort of payable okay but you know what we're looking at at this point is just that initial recognition of the expense you don't have to worry necessarily about discounts but if you're following it right through to the payment if we pay early we might receive a discount so that's something that you would need to include as well so that's accuracy and remember while i'm testing completeness and occurrence i can test accuracy using that same sample of documentation so don't go away and select new samples you can use just the samples that you've already collected now the last one that we've got here is cut off let me do this in a different color so that it's really clear let's use orange here so with cutoff it's is everything recorded in the correct financial period so here we don't need to select a sample over the entire period we can select just in a narrow band and usually it's like two to four weeks on either side depending on whether they use accounts payable or cash if it's cash only for expenses then you can make the window a little bit narrower a week or two weeks but you know two to four weeks is about usual so when we do what is sometimes called a cut-off test that's not very descriptive so i'm going to put in a bit more descript description here so i'm going to select so typically we're going to need to look at a block all right or we're going to stratify our sample now it depends on how many transactions there are if there are only a small number of transactions just select a block of transactions before and after the end of the financial period if it's a larger company you can't test all of them so you're going to need to select a sample so select a haphazard sample of now this is where you can do two different things all right so i'm gonna go option one here journal entries for expenses two weeks before and after the end of the financial year okay and with those journal entries what you're going to do is uh vouch to proof of receipt of the items goods must be received by the end of the financial year eofy all right so if i'm vouching i'm starting at the journal i'm going back i want to make sure the items were received before the end of the financial year the other option um option two here and you could probably you should probably do both of these rather than just do one do both of them attack the problem from both ends of the spectrum and meet back in the middle so select a sample of receiving reports and trace to the journals all right goods received oh my spelling is terrible today before or on the end of the financial year recorded in this period all right and that sample that you want to select there is transactions you know goods that you know that have been received before the end of the financial period so i'm going to add here a sample from two weeks before or on the end of the financial year i always like to check some transactions right on like the 29th or the 30th of june which in australia is our end of financial period it could be december whenever it is if you select some that are really close to the end of the financial year it's really common for accounting departments to perhaps you know have a inundated uh be inundated with purchases so they might not get to post some of these journals till later so it's really common to have mistakes here that need to be adjusted for so that's the way there with cut off i've actually got two tests one starting from after the end of the financial period and working backwards one starting from before the end of the financial period and sort of meeting together in the middle so those are all of our procedures and that's quite a lot here that you can see related to purchasing and expenses of course remember up here i talked about that we need to remember what type of expenses we're actually looking at um to really dig into designing some specific tests so these are really generic procedures but if you were asked in an exam to audit legal expenses then you're going to need to specify in more detail it's always better to be more detailed use information from the case and have it step by step so that you can get as many marks as possible from an assessment perspective customize those procedures to what you're actually looking at now of course this is not an exhaustive list if you've got any procedures that you've used in practice or that you've seen somewhere else or you want to ask me about share them in the comments with our community and i'll get back to you thanks for watching we've got plenty more videos in this series coming up i've got lots to do my schedule is a little bit off in terms of posting at the moment because of my real life job which is really starting to get intense at the moment with exams coming up we're heading to the end of semester and we're trying to plan out 2021 and what's going to happen but i will still keep having videos so i'd really appreciate it if you click to subscribe if you haven't already give the video a thumbs up if you thought it was useful and i want you all to stay safe stay well and i'll see you next time