audit assertions

What is the Meaning of Assertion in Audit?

An audit is a review of an entity’s financial statements and other information to assess its compliance with laws, regulations, contracts, and grant agreements. The auditor gathers evidence about the assertions made by management in order to form conclusions about whether those assertions are reasonable. Assertions may be related to accounting pronouncements or matters such as fraud. In this post, we will examine an auditor’s assertion to an auditor’s conclusion, and everything in between.

Assertion is a term that refers to the process of verifying something or, at times, disproving it. For example, if your accountant asserts that you have $5 million in assets, they are saying there is evidence to support this conclusion. If the auditor finds any discrepancies with these numbers during their review of your books and records then they will issue an adverse opinion because they disagree that you have those assets.

Auditors need to know what they’re looking for when they go through an audit because there are many different kinds of audits that can be performed on various entities under various circumstances.

What are assertions?

Assertions are a means of communicating an opinion about the completeness, accuracy, or consistency of one or more aspects of the financial statements. Assertions can be either positive (asserting that something is true) or negative (asserting that something is not true). There are two types of assertions: Type I and Type II.

There are two types of assertions…

What is a Type I assertion?

Type I assertions address matters within management’s control and relate to significant balances in the financial statements. They may relate to omitted amounts for assets and liabilities, off-balance-sheet transactions, incorrect application of accounting principles, errors in applying authoritative pronouncements on topics such as revenue recognition or depreciation methods; errors in identifying when events occur; applying appropriate discounts for lack of liquidity; improper disclosures about uncertainties; and failure to comply with laws or regulations.

What is a Type II assertion?

Type II assertions address matters outside management’s control (for example, unabsorbed losses from previous years). They may relate to the valuation of assets; recognition of revenues; classification of liabilities as either current or long-term; allocation of expenses between general and limited purposes funds; calculation of effect on fund equity of a change in grant or contribution terms and conditions; recognition of grants and contributions as either restricted, temporarily restricted, or unrestricted; presentation of an unclassified statement when one is required by GASB Statement 34 (The Financial Reporting Entity: Basic Concepts); correct application of the same accounting principles applied to general purpose governments; proper identification and recording of interfund transactions; and classification of interfund balances.

What are an auditor’s conclusions?

An auditor’s conclusions about assertions are based on the evidence gathered during the audit process, including an examination of documents such as contracts, minutes of meetings, and financial statements; interviews with management and employees; observation of accounting and other business processes; and tests of transactions and account balances.

What are the five audit assertions?

The 5 audit assertions are Accuracy, Completeness, Occurrence, Rights & Obligations and Understandability. So, let’s break that down.

Accuracy: this means the financial statements reflect all transactions that have occurred during the period.

Completeness: this means that the auditor needs to make sure there are no missing transactions, such as other investments or loans not recorded in the books but known by management; account balances may be incorrect if they do not include these transactions.

Occurrence: this means that all revenue and expense items should be included in the financial statements.

Rights & obligations: this means that the auditor needs to ensure creditors and debtors are being treated fairly, for example by making sure invoices have been issued for services rendered or products delivered.

Understandability: this is also sometimes called “comprehensibility.” The auditor needs to make sure that the financial statements can be understood by all users, not just those with a finance background.

These five assertions are at the heart of an audit and should be considered when reviewing any company’s financial statements.

How many types of assertions are there in auditing?

It depends on what type of audit is being performed. For example, financial audits are concerned with the fairness of financial statements.

The assertion is on whether an account balance or other information in a financial statement is fairly presented. ¨This means that it should be free from material misstatement, bias and significant errors.”

Other types of auditing include compliance auditing which includes making sure people and businesses are following the law, operational auditing which is concerned with how well a company’s business processes are working and information technology audits.

Each of these types of audits have different assertions that need to be made in order to ensure accuracy and completeness of data.

What are classes of transactions?

Classes of Transactions are the building blocks of an audit. Without classes there is no basis for planning, conducting or reporting on work performed. For example, a financial audit will have a series of classes such as cash, accounts receivable and inventory. The auditor must also decide the level of evidence to be gathered for each class which is then used in making an assertion about whether that particular account balance or item is free from material misstatement.

What are kinds of transactions?

Kinds of transactions are the types of transactions that can occur within each class. For example, in the inventory account there may be several kinds such as raw materials, work-in-process and finished goods. Each kind could have its own level of evidence required for an assertion to apply.

What is management assertions?

Management Assertions provide a basis for the auditor to form an opinion on a company’s financial statement. The assertions are about whether the financial statements present fairly, in all material respects, the financial position, results of operations and cash flows of the company.

For each assertion, the auditor must consider which classes of transactions apply and then determine how much evidence to gather in order to support that particular assertion. Management Assertions relate only to financial statement presentation because they are based on assertions about whether the statements present fairly what management has done over a given period of time.

What is misstatement?

Misstatements are the result of errors, omissions and fraud. Only material misstatements can be used to support an assertion about whether a financial statement is free from material misrepresentation or omission so auditors must determine which transactions contain these types of problems in order to issue their opinion on each assertion.

What is evidence?

Evidence in an audit includes all documentation and information that can be used to support the auditor’s opinion on each management assertion. Each class of transactions may have its own level of evidence required for a given assertion so auditors must determine which documents or pieces of data are relevant to their work. Evidence also refers to the tests that are performed to gather information about a particular class of transactions. For example, an audit of cash would include verifying the balance as well as reviewing cancelled checks and bank statements.

What is materiality?

Materiality is one of the most important concepts in auditing. It is the determination of whether an error, omission or misstatement is material enough to be a concern. For example, if inventory was understated by $100 at the end of a fiscal year an auditor would have to determine whether this particular error/mismanagement had any significant impact on the company’s financial position and results of operations.

Materiality can vary from transaction to transaction which means that the auditor will have to determine whether a misstatement is material or immaterial for each class of transactions. For example, if inventory was understated by $100 but only represented 0.01% of total assets then it would likely be seen as an immaterial error whereas $100 out of $1000 in cash could be considered material because it represents half of one percent.

…amount and type of information necessary for auditors to make a decision…

What is the level of evidence?

The level of evidence in an audit refers to the amount and type of information necessary for auditors to make a decision on whether any given assertion can be issued or not. For each class within the financial statements, there will likely be different levels required depending on what types transactions are involved. The auditor would have to determine which level is necessary and then gather that type of information in order for their opinion of the financial statements to be accurate.

What are some examples?

Some common kinds of transactions include assets, liabilities, revenues and expenses. Each of these will likely require a different level of evidence depending on what type of transactions are involved. For example, the level of evidence required for testing cash would be different than that required for verifying accounts receivable since cash is a current asset and account receivables are non-current assets.

The auditor will have to determine what level of evidence is needed in order to issue their opinion on each class including management assertions.

In conclusion on financial statement assertions

In conclusion, auditors must determine which transactions contain these types of problems in order to issue their opinion on each assertion. The level of evidence can vary from transaction to transaction and the auditor will have to determine what type is necessary for them to make a statement about management’s assertions within financial statements. Therefore, it is important that auditors know and understand the meaning of assertion in an audit.

Caveats, disclaimers & financial statements

At ESG | The Report, we believe that we can help make the world a more sustainable place through the power of education. We have covered many topics in this article and want to be clear that any reference to, or mention of transactions recorded, publicly traded companies, liabilities and equity balances, substantive procedures, valuation assertion, existence assertion, accounting standards, completeness assertion, explicit claims, assertions related, certain aspects, other words, net realizable or ownership rights in the context of this article is purely for informational purposes and not to be misconstrued as investment or any other legal advice or an endorsement of any particular company or service. Neither ESG | The Report, it’s contributors or their respective companies or any of its members gives any warranty with respect to the information herein, and shall have no responsibility for any decisions made, or action taken or not taken which relates to matters covered by ESG | The Report. As with any investment, we highly recommend that you get a financial advisor or investment adviser, do your homework in advance of making any moves in the stock market. Thank you for reading, and we hope that you found this article useful in your quest to understand ESG and sustainable business practices. We look forward to living together in a sustainable world with you.