ACT501 Chap.5 Management Assertions and What Could Go Wrong
Management Assertions and What Could Go Wrong
Representations that arrive with the document
Management assertions are the claims, spoken or merely implied, that management makes about how items in the accounts have been recognised, measured, presented and disclosed. They come with the act of putting statements forward as drawn up under a reporting framework. Nobody signs a list of them.
The accounts carry claims about what happened during the period and the disclosures tied to it, and separate claims about the balances standing at the period end and the disclosures tied to those.
Responsibility for them sits with management and, where relevant, with those charged with governance, and that division of roles is what makes an audit possible.
Two families, three members each, three shared
Assertions about account balances at the period end are existence, rights and obligations, completeness, accuracy with valuation and allocation, classification and presentation.
Assertions about classes of transactions and events over the period are occurrence, completeness, accuracy, cutoff, classification and presentation. The first family belongs primarily to the balance sheet, the second primarily to the income statement, the statement of changes in equity and the statement of cash flows.
Completeness, classification and presentation appear in both, because whether something was captured at all, filed in the right place and described understandably does not depend on which statement the item lives in.
Direction of concern
Each assertion guards one direction of error and a procedure designed for one direction cannot detect the other.
Existence and occurrence guard against overstatement: the concern is that something recorded is not real. Completeness guards against understatement: the concern is that something real was never recorded. The asymmetry is structural rather than psychological. A recorded item that does not exist is visible in the accounts, so it can be selected and traced back to its origin.
An item that should have been recorded and was not is invisible in the accounts by definition, so it can only be found by starting outside them.
Two questions that look symmetric therefore need procedures running in opposite directions.
A second published set
A combined set used by the American listed-company regulator merges some of these: existence or occurrence, completeness, cutoff, rights and obligations, accuracy with valuation and allocation, and presentation and disclosure.
Nothing conceptual changes, but the inspection reports the group project uses are written in that vocabulary, so being able to map one set onto the other is worth the few minutes it takes.
The chain that turns an assertion into work
Each claim is used to think through the kinds of error that could arise while the team is locating, sizing and answering the risk of material misstatement.
They give the auditor a road map for deciding what evidence to collect, and they guide the design of the procedures that collect it. Each assertion raises a question that evidence can answer, and when sufficient appropriate evidence persuades the auditor that no material misstatement attaches to each relevant assertion, an opinion can be expressed.
Worked on receivables, the chain produces four separate pieces of work: a fictitious customer answered by confirming balances; receivables sold or factored answered by asking management and reading the finance agreements; unrecorded customer accounts answered by agreeing the subsidiary ledger to the control account; and a long-overdue balance kept at its full figure answered by testing whether the bad debt allowance is big enough.
Where the marks sit
In naming the direction.
Saying that a consignment arrangement raises a rights and obligations question is correct and uninformative. Saying that it means revenue and receivables are overstated while inventory may be understated shows that you know what the arrangement does to the accounts, and it makes the choice of procedure follow rather than float.
It also catches your own errors: if the procedure does not run in the direction just named, one of the two is wrong.
What this chapter covers
- 01
Representations inherent in presenting financial statements
- 02
Who is responsible for the assertions, and who is not
- 03
Six assertions about balances at the period end
- 04
Six assertions about transactions and events over the period
- 05
The three members shared between the two families
- 06
Direction of concern, and why it is structural rather than motivational
- 07
The combined set used in listed-company inspection reports
- 08
Assertion to possible misstatement to evidence to procedure
- 09
Four separate questions on one receivables balance
Three facts, three assertions, three directions
- 3Name the assertion and the family it belongs to for each fact.
- 3State the direction the misstatement runs and what it does to profit.
- 3Give a procedure that could detect an error in that direction.
Key terms
- Management Assertion
- A claim, spoken or merely implied, about how an item in the accounts has been recognised, measured, presented and disclosed, arising from the act of putting the accounts forward under a reporting framework.
- Existence
- The claim that assets, liabilities and equity interests recorded at the period end actually exist. Its concern is overstatement.
- Occurrence
- The claim that recorded or disclosed transactions and events took place and pertain to the entity. Its concern is overstatement.
- Completeness
- The claim that nothing which belonged in the books has been left out. Its concern is understatement, which is why the ledger is the wrong place to test it from.
- Cutoff
- The claim that a transaction has been booked in the period it belongs to.
- Rights and Obligations
- The claim that the business owns or controls its assets and that the liabilities shown are its own to settle.
- Accuracy, Valuation and Allocation
- The claim that amounts carried are the right ones, with every valuation or allocation adjustment properly booked and the linked disclosures properly measured and described.
Management Assertions and What Could Go Wrong FAQ
What assertions is a company making when it reports an inventory figure?
At least four that carry real audit work. Existence, that the recorded quantities are physically there. Rights and obligations, that the company owns them rather than holding them for somebody else. Completeness, that everything owned is included, including goods in transit and stock at third-party locations.
And accuracy with valuation and allocation, that the figure is carried at the lower of cost and net realisable value with damaged and obsolete lines written down. Classification and presentation add that the split between raw materials, work in progress and finished goods is right and the costing method is disclosed.
Why can completeness not be tested by sampling the ledger?
Because the population being sampled excludes the error by construction. An unrecorded liability is not in the payables ledger and an unbilled despatch is not in the sales journal, so neither can ever be drawn into a sample taken from those places.
A completeness test has to start outside the accounting records, with goods received notes, despatch documentation, supplier statements or payments made after the year end, and follow them forward into the ledger.
Do I need to learn both assertion sets?
You need to be able to move between them, which is less work than learning two lists. The merged set used in listed-company inspection reports combines existence with occurrence and combines presentation with disclosure, and keeps completeness, cutoff, rights and obligations and accuracy with valuation and allocation.
Since the group project reads those reports, recognising that vocabulary is practical rather than decorative, and an answer that maps one set onto the other in a clause shows genuine command of both.
Exam move
Take the balance sheet of any company you can find and work three captions completely: for each, write the assertion, the direction, what could go wrong, and the procedure. Twelve short lines.
Then check whether any procedure you wrote starts inside the ledger while the direction you named was understatement, because that is the mistake the whole chapter exists to prevent and finding it in your own work is how it stops recurring.
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