Auditing Assertions Illustrated, Solutions

Some Illustrations:
1. Sale transaction happens on 12/25/12 but the company fails to record it:
The following accounts and assertions are involved. Sales & COGS: Completeness
Transaction Assertion; Accts Receivable (or Cash, if a cash sale): Completeness
Balance Assertion; Inventory: Existence Balance Assertion. If shipping fees, sales
tax, or other items are involved, then those associated accounts may also be misstated.
Because of the errors in Sales and COGS, Equity (Retained Earnings) will also be
misstated by the net effect. In the example below, this would be a $40 understatement
($100 - $60), before considering tax effects [What assertion(s) would we use to
describe the misstatement in Equity?]. Be careful about double counting the effects
of misstatements though. It's not two separate misstatements, but rather a single
misstatement that affects both the income statement and equity.
It's helpful here to visualize what should have happened (but didn't) by using T-accounts.
Just so we can have some numbers to use, assume that the sale was for $100, and that the
company's cost for the goods sold was $60.
Record the Sale:

Record the corresponding shipment of inventory and Cost of Goods Sold:

The company took in $100 cash or an equivalent receivable, which is an asset that they
really do have, but they failed to record (completeness). They also have the $100 sale
they forgot to record (completeness) and the $60 COGS (completeness). At the same
time, their financial statements will reflect $60 worth of inventory that they no longer
have because they sent it to a customer. This violates the existence assertion for
inventory.
Of course the entire example above is overly simplistic. This is partially because it
ignore tax effects, which we will do in this course but which you can't do in practice. The

bigger problem though is that it ignores the end of year accounting processes that the
company will have in place. The most important process in this regard is the physical
inventory count that will occur at the end of the year, and the impact of any adjustments
to the accounting records as a result. Can you identify the misstated accounts and
assertions if we include the physical inventory count into the analysis?
Solution:
The company will adjust inventory for the actual count, and debit/credit an Inventory
Over/Short account for the adjustment. In this case, they will credit Inventory when they
find that actual inventory is $60 short of what was recorded, and debit the Inventory
Shrinkage account by the same amount, like this:

Inventory adjustment accounts like this are closed to Cost of Goods Sold, so you can just
treat this as a debit to COGS. This fixes two of the misstated accounts from earlier in the
example, but leaves the others in error.
2. Sale transaction is recorded on 12/25/12 but never actually occurred:
Occurrence Transaction Assertion (Sales & COGS); Completeness Balance Assertion
(Inventory); Existence Balance Assertion (A/R or Cash).
3. Sale transaction happens on 12/25/12 and is recorded on 1/3/13:
Cut-off Transaction Assertion (Sales & COGS) in both 2012 and 2013 -- this equates to a
Completeness violation in 2012 and an Occurrence violation in 2013;
Existence Balance Assertion (Inventory) in 2012, but not in 2013; Completeness Balance
Assertion (A/R) in 2012, but not in 2013 unless the customer paid before the
receivable was recorded and the company failed to properly reflect payment of the
invoice.
4. Sale transaction happens on 12/25/12 and is accidentally recorded twice in 2012.
First recording is no problem. On the second recording, the same transactions are
violated as in example 2 above.
5. A/R subsidiary ledger has 100 accounts. Account #95, John Smith, is left out of the
A/R control account in the general ledger:
Completeness Balance Assertion (Accts Receivable). Note that if debits equal credits on
the financial statements, then another account must be out of balance, or else the

overall financial statements won't balance. But without investigation we wouldn't

know whether it's Cash, Sales, Retained Earnings, or some other account.
6. A/R subsidiary ledger has 100 accounts. Account #95, John Smith, is accidentally
added into the A/R control account twice:
Existence Balance Assertion (A/R). Note the same issue as #5, where another account
must be out of balance somewhere for the financial statements to balance.
7. A/R subsidiary ledger has 100 accounts. All are included only once in the A/R control
account, but they are summarized (added) incorrectly:
Valuation / Allocation Balance Assertion (A/R), with the same balancing issue as #5 and
#6.
8. A/R subsidiary ledger has 100 accounts, all included and correctly summarized in the
A/R control account. Account #95, John Smith, overpaid, resulting in a material (i.e.,
"large") credit balance:
Presentation & Disclosure Classification Assertion (credit balance in A/R should be
classified and reported as accounts payable).
9. A company lists as PP&E a building it properly owns but does not use for any purpose:
Presentation & Disclosure Classification Assertion (should be classified as an
investment, not as PP&E). In addition, the company recorded depreciation expense
on the building this year: Valuation / Allocation Balance Assertion for the asset
(taking depreciation on a non-depreciable asset leads to incorrectly reporting net
realizable value), and Occurrence Assertion for a depreciation expense that never
should have been recorded.
10. A company lists a building as PP&E, when in fact the title to the building is held in
the name of the company's owner and has never been transferred to the company:
Rights & Obligations Balance Assertion. If the company is also taking depreciation on
it, then the same additional violations as #9.
The above examples are fairly simple. Below are examples that partially touch on a
number of assertions, and illustrate how misstatements don't always fit neatly into a
specific category of assertions:
11. A company records a sale to a customer when it never had a reasonable expectation
of being paid by the customer.

There are two parts to this transaction: (a) the company recorded a debit to Accounts
Receivable and credit to Sales; (b) and a debit to Cost of Goods Sold and credit to
Inventory. The transaction cannot properly be recorded as revenue since there was no
reasonable expectation of payment. The sale portion of the transaction never really
happened, according to GAAP requirements for revenue recognition. Thus, the "sale"
did not really occur (Occurrence Transaction Assertion), although the right to receive
payment does exist. But you did really ship merchandise to the customer, so the
portion of the transaction that you recorded as a credit to Inventory and debit to Cost
of Goods sold did occur (so Occurrence is O.K. for this part of the transaction). But,
the debit probably should have gone to a loss account rather than to CGS (since the
transaction can't be recognized as a Sale according to GAAP). Thus, the problem
with the second part of the transaction is more related to properly classifying the
transaction (Transaction and Presentation & Disclosure Classification Assertions).
12. Same as above, except that at the time of the transaction the company did have a
reasonable expectation of being paid by the customer. In addition, assume that the
company properly estimates bad debt expense, did not know at the financial statement
date that the account is uncollectible, and did not write off the account.
In this scenario, recording the sale is proper (so the Occurrence Transaction Assertion is
O.K.) and the company has the right to receive payment (Rights / Obligations
Balance Assertion is O.K.). The company makes a reasonable estimate of its
uncollectible accounts (Valuation / Allocation Balance Assertion is O.K.) and nets this
against the gross balance in A/R on the financial statements (Presentation &
Disclosure assertions are O.K.). So no assertions are violated. In fact, this scenario
reflects the proper method of accounting for accounts receivable.
13. Same as 12, except that the company uses the Direct Write-off method for bad debts
(remember from Intermediate Accounting that direct write-off is non-GAAP).
Assume that the account is uncollectible at the financial statement date, but the
company did not make a reasonable attempt to write down the receivables to net
realizable value (which is the purpose of estimating bad debts and recording the
allowance for uncollectible accounts).
Thus, Valuation / Allocation Balance Assertion is violated. Specifically, the "valuation"
part of the assertion is violated.