In her first week at an accounting firm, Meredith Mednick, CPA, CA, looked ready. She had a new laptop bag, a carefully planned business-casual outfit, and the determination to start strong.
Then Dana, her confident third-year senior, dropped a binder on her desk and said, “We’re starting our audit with revenue. Pull the assertions.”
Meredith smiled, nodded, wrote it down, and immediately searched for “audit assertions” under the table.
If that sounds familiar, Episode 2 of Audit Fundamentals is for you. Meredith begins with a question every auditor should ask: If you don’t know what you’re trying to prove, how will you know when you prove it?
Audit assertions answer that question. They connect management’s claims to the evidence we need and give each audit procedure a clear purpose.
Financial statements contain specific claims
Audit assertions are the explicit or implied representations management makes about financial statements and the transactions and balances behind them. When a CFO approves the statements, management claims the information is fairly stated.
Our job isn’t to assume management is wrong. But we can’t simply take management’s word for it. We must gather sufficient, appropriate audit evidence to support or challenge each claim.
Meredith compares this process to buying a used car. The seller says the car runs well, the mileage is accurate, and the title is clear. A careful buyer still consults a mechanic, checks the Carfax, and verifies the title. The buyer isn’t calling the seller a liar when they independently test the claims.
Assertions organize that testing into two groups:
- Assertions about transactions and events during the period
- Assertions about account balances and disclosures at period-end
Understanding the difference is crucial because transactions and balances can fail in different ways. With that framework in place, we can examine the five transaction-level assertions.
Five questions test activity in the ledger
For every transaction, ask these five questions:
- Occurrence: Did it happen? Suppose the revenue ledger includes a $500,000 sale dated December 15. Vouch from the ledger back to the invoice, contract, shipping document, or proof of delivery. This helps detect fictitious or premature revenue.
- Completeness: Did we capture everything? Start with source documents and trace them forward into the ledger. For accounts payable, those documents might include vendor invoices, purchase orders, and receiving reports. Occurrence asks whether recorded items are real; completeness asks whether real items are missing.
- Accuracy: Is the amount right? Recalculate the price, quantity, terms, and other data. For a foreign-currency transaction, verify the exchange rate and whether they used the correct type of rate, such as the spot rate on the transaction date or a permitted average rate.
- Cutoff: Is it in the correct period? If $2 million of inventory ships on December 30 but they process the invoice on January 3, determine which period should include the revenue. Test transactions on both sides of year-end because revenue can be pulled forward and expenses can be pushed back.
- Classification: Is it in the right account? A $50,000 exterior paint job is generally an operating expense. If it was part of a major renovation that extended the building’s life, the accounting could differ. As Meredith says, “Context always matters.” Read the supporting agreements and document your reasoning.
Those questions address activity during the year. Period-end balances require a related but different set of tests.
A balance can look right without being right
The five main balance and disclosure assertions focus on what appears in the financial statements at a specific date:
- Existence. Are the assets, liabilities, and equity interests real? A schedule listing $10 million of inventory doesn’t prove the goods are present. Attend the inventory count, obtain bank confirmations, send receivable confirmations directly to customers, and inspect fixed assets. If a customer doesn’t answer a confirmation, use alternative procedures such as reviewing later cash receipts, invoices, and shipping documents.
- Completeness. Did the client record everything that should be recorded? This assertion is especially important for liabilities. Search for unrecorded obligations by reviewing invoices received after year-end, subsequent events, board minutes, loan agreements, and attorney letters.
- Valuation and allocation. Did the client record balances at appropriate amounts? A confirmed $5 million receivable may exist but be worth less than $5 million. Test management’s calculations, methods, and assumptions. If a major customer filed for bankruptcy, an allowance model based on five years of unchanged assumptions may not be reasonable anymore.
- Rights and obligations. Does the company own or control its recorded assets, and are its liabilities genuine obligations? An $800,000 machine may exist but be leased, pledged as collateral, or owned by a related party. Consigned inventory shouldn’t appear as company-owned inventory when title hasn’t transferred.
- Presentation and disclosure. Did the client properly classify, describe, and disclose all items? Read the statements and footnotes from beginning to end, compare them with the reporting framework, and tie the notes back to the financial statement amounts.
Once we understand these assertions, the next step is to decide which ones matter most for each account.
Risk should drive the audit program
We shouldn’t give every assertion equal attention. The risk of material misstatement determines the procedures we design:
- Revenue. Focus on occurrence and cutoff because fictitious or premature sales can inflate results
- Inventory. Focus on existence and valuation because inventory is physical and can be difficult to measure
- Accounts payable. Focus on completeness because liabilities may be understated
A single issue can affect more than one assertion. For example, a sale recorded on December 31 with a January 2 shipping document raises both cutoff and occurrence concerns.
Turn each procedure into evidence
Meredith compares an audit to a prosecutor’s case. A prosecutor must prove specific elements with specific evidence. Auditors do the same. We test specific assertions for significant accounts and disclosures.
For every procedure, ask:
- What am I trying to prove?
- Which assertion does this procedure address?
- Is this procedure the right one to test that assertion?
- Have I documented that connection clearly?
If you can’t identify the assertion, there may be a gap between the work performed and the conclusion reached. Understanding that connection helps us move from completing procedures to understanding why they matter.
Listen to the full Audit Fundamentals episode for Meredith’s complete walkthrough. Above all, keep asking the question behind every procedure: What am I trying to prove?