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March 1993

The five assertions - a revisit. (categories of assertions about which auditors must collect adequate evidence to support financial statement items) (Auditing)

by Rouse, Robert W.

    Abstract- Statement of Accountant Standard (SAS) No 31, 'Evidential Matter,' identifies the five general classes of assertions about which auditors are required to collect enough relevant evidence to lend credence to the items reflected in the financial statement. Issued in Aug 1980, this pronouncement classified assertions according to existence, completeness, valuation, rights and obligations, and presentation and disclosure. SAS 31 also calls for auditors to set audit goals for every assertion for all important account balance or class of transactions. Selection of audit procedures that would generate the evidence needed to support the audit goals is likewise recommended. It is essential for auditors to re-examine SAS 31 because many of them still do not comprehend the need for performing procedures specified in standard audit programs and financial statement assertions.


SAS 31 states, "Assertions about existence or occurrence deal with whether assets or liabilities of the entity exist at a given date and whether recorded transactions have occurred during a given period." Where does the auditor begin to support this assertion? Answer: The books and the ledger gather evidence that a transaction has occurred because the accounting system "captured" the transaction by recording it.

In testing for existence, the auditor should seek evidence outside the books for that which has been recorded. The effort cannot stop with finding supporting debits and credits in a book of original entry. The effort must extend beyond the confines of the accounting records to persuasive evidence of the existence of the tangible or intangible asset or liability.

Substantive testing for the assertion of existence frequently involves some type of confirmation with an outside third party. For example, a long-standing auditing procedure to be used where practicable is the confirmation of receivables. Although the client may be involved in the generation of the confirmations, especially in the computer environment, the auditor is cautioned to retain control over the confirmation process and not to be influenced by a client's comments as to why a receivable should or should not be confirmed. The auditor should exercise due care to determine the legitimacy of the address of the person to whom receivable confirmation is being sent.

Confirmation of cash account balances is another example of a common test for existence. Recognizing the deficiencies in the confirmation process, the AICPA has recently changed the format of the standard confirmation form to restrict it to a request for balances of the cash accounts. Information regarding loans, lines of credit, or other financial arrangements must be sought by a separate communicator to the bank official that would be familiar with such matters.


SAS 31 states, "Assertions about completeness deal with whether all transactions and accounts that should be presented in the financial statements are so included." To support the completeness assertion, the auditor obtains sufficient, competent evidence that transactions that should be recorded have been recorded. The concept of materiality allows the auditor to support the statement that a sufficient number of transactions--as opposed to all transactions--have been recorded. Testing to support completeness originates with externally generated documentation that a transaction has occurred. The presence of tangible assets in a retail client's possession is evidence that the asset has been acquired. An invoice from a vendor and a receiving report from the warehouse supervisor or receiving clerk are examples of documents that are indicative that transactions have occurred and should be recorded. The direction of the effort is from the asset or from the externally created documents to the entries in the journal, to the ledger, and to the balance.

How does the auditor gather sufficient evidence to support completeness? If internal control policies and procedures are adequate, there is a reasonable assurance that all transactions are being captured and recorded. Also, the use of analytical procedures can be helpful in satisfying this objective. If the auditor has appropriate "benchmarks"-- trend analyses, ratios that make sense, there may be significant support for the completeness assertion.

Analytical procedures have received much publicity and have been the source of numerous continuing education courses and articles. Many software packages can be purchased which provide a plethora of numbers and ratios in exotic fashion. However, this information can be totally worthless without the appropriate analysis that the results make sense.

Analytical procedures cannot prove that all individual transactions were recorded, but may provide evidence that a sufficient number has been recorded to make the financial statements free from material misstatement. A ratio or other analytical procedure that produces an unexpected result may indicate that too many or too few transactions have been recorded.

As the confirmation of receivables may provide sufficient competent evidence for the existence assertion, the ratio of cost of goods sold to sales may suggest that all sales have been recorded. However, the calculation of such a ratio should be analyzed with consideration of any changes in business and the present economic environment.

An auditing technique that can be used to gather evidence regarding both existence and completeness as it applies to inventory illustrates the importance of the direction of the stated procedure. Before going to the warehouse to observe the inventory, the auditor reviews selected entries in the subsidiary ledger. In the warehouse those entries are vouched to the tangible inventory-support for existence. While in the warehouse, the auditor makes physical counts of other items of and traces them to the inventory ledger--support for completeness.


SAS 31 states, "Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense components have been included in the financial statements at appropriate amounts." The auditor has the guidance of GAAP to measure or disclose transactions and balances. On the surface, this assertion appears to be one of the least troublesome. However, the auditor should determine that the audit procedures selected are suitable for accomplishing the audit objective related to the assertion. For example, confirmation of accounts receivables provides valid evidence relating to the assertion of existence. However, the fact that the client's customers indicate that the amount on the face of the confirmation is correct provides little, if any, evidence that payment is assured. Valuation can be supported by the process of aging the current accounts receivable to evaluate the adequacy of the allowance account.

Rights and Obligations

SAS 31 "assertions about rights and obligations deal with whether assets are the rights of the entity and liabilities are the obligations of the entity at a given date." The adage "possession is nine-tenths of the law" hardly prevails in today's GAAP as many efforts are constantly being exerted to remove accounts from or simply not place them in the financial statements while retaining the use of the asset. Off statement financing has frequently resulted in an entity's receiving the use of an item without measuring or disclosing the transaction in the statements.

Special purpose entities (SPEs) are sometimes created to be parties to off-financial-statement items. An example is a build-to-order lease transaction as it relates to SPEs. An SPE--lessor--retains title to a leased asset but relinquishes all control and risk to the lessee, which assumes "substantially all the risks and rewards of ownership." If the SPE is owned by the lessee, the need for consolidation of the two entities--lessor and lessee--for financial reporting appears necessary. The auditor is cautioned to determine that the accounting for the transaction reflects the substance regardless of the form it takes.

Presentation and Disclosure

SAS 31 "assertions about presentation and disclosure deal with whether particular components of the financial statements are properly classified, described, and disclosed." The account balance not only must be properly measured but also adequately described and disclosed. A trade receivable, a receivable from an employee, a loan to an employee, and a loan to a related party are all receivables and usually can be readily measured at net realizable value. However, the presentation of each must reflect the individual characteristics of the transactions.

The inventory account also poses the same challenge. Proper disclosure includes presenting the method of inventory valuation, the stage of completion if a part of a manufacturing process, and any financial arrangements involving the pledging of the assets.

When accounting for environmental and other related contingencies, adequate disclosure is crucial because the criteria for recording a liability are frequently not present. The inability to properly value the contingency should not automatically remove from the auditor's consideration the need for disclosure.

Other complexities involve the disclosures of bond and equity securities. In most cases the values of these securities are readily accessible--many are traded on exchanges--but the disclosure of these securities as investment, trading, or held for sale classifications is determined by the intent and the ability of the client to carry out that intent. It is critical that the auditor obtain sufficient, competent evidence supporting the classification because the financial statement classification drives the valuation. If the security is disclosed as an investment, amortized cost is the basis; if held for sale, lower of cost or market; if trading, market value.

The FASB recently issued an ED on the subject. The FASB recently issued SFAS 107, Disclosures about Fair Value of Financial Instruments, which requires the disclosure of the fair values of financial instruments and the methods of determining these values. These disclosures can be placed in the notes or in the body of the financial statements and are required of entities with assets in excess of $150 million.

Procedures Must Be Driven By Objectives

Auditors have been slow in adjusting to the concepts of assertions expressed in SAS 31. It has taken a new generation of auditors to move the assertions to center stage. The time is now for auditors to put aside old ways and design procedures that address all the assertions as called for in auditing standards.

Robert W. Rouse, PhD, CPA, College of Charleston.

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