A Five-Minute Demonstration of
Assertion-Based Auditing
Paul M. Clikeman
University of Richmond
January 2007
SAS No. 106, Audit Evidence, instructs auditors to test the existence, completeness, and valuation of period-end account balances. The financial statement assertions provide a logical framework for designing audit tests. I have told my auditing students for years that there are only three types of errors that can cause an account balance to be misstated: (1) the account contains an entry that does not belong in it, (2) an entry that belongs in the account has been omitted, or (3) an entry has been recorded for the wrong dollar amount. Auditing an account balance, therefore, requires verifying that the recorded transactions occurred and belong in the account (existence or occurrence), searching for omitted items or transactions that should be recorded in the account (completeness), and testing whether the account entries have all been recorded at the proper dollar amounts (valuation). Students who fail to understand financial statement assertions often have trouble selecting audit procedures to search for potential account balance misstatements.
One simple, yet effective, exercise to demonstrate assertion-based auditing is to ask students to open their textbooks to the Table of Contents—a one-page "Brief Table of Contents" is ideal. The Table purports to describe accurately and completely the book's contents. Ask the students to generate a list of errors that might occur during the book's printing or during the Table's construction that would make the Table an inaccurate summary of the book's contents. One potential error is that the printer might lose (and therefore not print) one or more chapters submitted by the authors. In this case, the Table of Contents would list chapters that don't exist in the book. Or the authors might write a new chapter at the last minute and forget to add the new chapter to the Table of Contents. In that case, the Table would be incomplete. Or the printer might accidentally put the chapters in the wrong order. All the chapters listed in the Table of Contents appear in the book, but the page numbers are incorrect. This is roughly analogous to a valuation error.
For each potential error, ask the students how they would test to see if the error had occurred. Most students understand intuitively that to test whether any chapters are missing, they would select a sample of chapter titles from the Table of Contents and search for the selected chapters in their book. To test completeness, a student might open the book randomly, make note of the chapter he or she finds, and then turn to the Table of Contents to see if the chapter is listed. To test valuation, a student would compare the page numbers listed in the Table of Contents to the numbers on the first page of each chapter.
I use this exercise during the second or third week of my introductory auditing class and refer to it repeatedly during the semester. When we discuss accounts receivable, I tell the students to think of the client's accounts receivable trial balance as a "Table of Contents" purporting to describe all the amounts due from the client's customers. How would an auditor test whether the customers listed on the trial balance really exist and owe money to the client? How would an auditor search for receivables that exist but are not listed on the trial balance? How would an auditor test whether the account balances listed on the trial balance are accurate?
When we discuss accounts payable, I ask the students to consider the following question:
An author takes a manuscript to a printer and orders 1,000 copies. The author agrees to pay the printer $10 per copy. The printer must pay for the paper and ink used in producing the books. Which would the author worry about more—that the printer might omit some of the manuscript pages from the printed books or that the printer might add unwanted material to the books?
Before accepting delivery and paying for the books, the author will probably spend more time examining their completeness than looking to see if the printer added extra pages. Similarly, auditors usually spend more time testing completeness than existence when examining accounts payable.
Jay Thibodeau, Greg Jenkins, and Dick Reilly stated in their article "Audit Education for the Post-Sarbanes Audit Environment" (The Auditor's Report, Volume 29, No. 2, Spring 2006), "… financial statement assertions are now central to the audit process. Accordingly, students need to have an in depth understanding of the assertions, including tying assertions to controls and substantive testing." This five-minute exercise, performed early in the semester, helps my students understand the concept of financial statement assertions and helps them write audit programs that address all possible account misstatements.
Paul M. Clikeman
Associate Professor of Accounting
Robins School of Business
University of Richmond
Richmond, VA 23173
804.287.6575
pclikema@richmond.edu
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