When conducting an audit, auditors are required to test management's assertions that the company's assets exist and the company has the right to hold the assets on the balance sheet. For common assets, auditors have standard procedures they use to test these assertions. By understanding how an auditor is going to proceed, you'll know what to expect from your auditor before he ends up in your office asking questions.
Cash
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Auditors are principally concerned that cash balances exist. To test this assertion, auditors will usually send confirmation requests to the client's bankers. This standard form will ask bankers to verify the client's balance as of the end of the fiscal year. It is important to remember that the auditors will want to send these requests themselves and receive the bank's response at the audit firm's address as well. In the past, frauds have been concealed by forged bank confirmations. Therefore, generally accepted auditing standards (GAAS) require that confirmations are sent and received under the auditor's control. Also, companies that have restricted cash balances pledged as collateral may require special audit procedures to determine who has legal title to the cash in question.
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Investments
Companies that hold investments in stocks and bonds may have significant cash amounts tied up in these financial instruments. Auditors will want to make sure that these investments exist and that the company has the right to the funds held in the investment. For most investments, confirmations are sent to investment companies and brokerage firms. However, there are a few exceptions. Companies that hold bearer bonds will have an auditor physically examine the bond to make sure that it exists and is valid. In addition, companies that hold investments in private companies or other illiquid investments may need to demonstrate how they arrived at the valuation of their stake in the investment.
Accounts Receivable
Companies that sell goods or services on credit maintain balances of accounts receivable. To test the existence and rights assertions of accounts receivable, auditors will send confirmation requests to the company's customers. These requests typically ask the customer to confirm that it owes the amount of the receivable to the company being audited. In theory, this works well; however, it is common that the client's customers will not respond or will not fill out the confirmation request properly. In these cases, the auditor will examine evidence of the receipt of cash after year end. This technique operates on the assumption that if the customer paid the company immediately subsequent to year end then the the debt was owed at year end.
Property, Plant and Equipment
In order to test the existence and rights obligations for property, plant and equipment, auditors usually try to physically observe the asset. Given a listing of the company's equipment, auditors will then select an asset from the listing and see the asset in service at the company. It is important that the auditor determines that the asset listed in the company's asset register is the asset that is being observed. To ensure that this is the case, auditors will match the serial number or asset tag to the listing.