#65 Impairment Testing

Auditing & Accounting experts foreseen that impairment testing on intangible assets, fixed assets, investments, assets, etc has to be assessed crtically in a detailed basis in the coming year, subsequent to the credit crunch.

The recession has driven the stock prices down, the value of the intangible assets sank accordingly. The recession acts as a trigerring points for the impairment testing.

Hence, the auditors should highlight to the clients that the impairment testings have to be performed earlier ( rather than sometimes near the audit), as the impairment testings required a lot of times. Rigid assessment by auditors are required, given the fact that financial statements users will be using the financial statements more cautiously.

Work life balance in Big 4

Let's define what's big 4?

Big 4 was defined as 4 largest accounting firms in the accounting profession worldwide. The Big 4 consist of the following entities: Pricewaterhouse Coopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG.

Auditors in Big 4, in general, have long working hours. Working till midnight and over the weekend is a norm in the industry. We've heard about the heavy work load, stressful life and long working hours of auditors who work in Big 4 audit firms. However, what are the factors cause the long working hours in Big 4?

It is due to the portfolio of the clients that Big 4 have. Majority of the listed companies would engage one of the Big 4 audit firms as their auditors. Having high volume of transactions and relatively more complicated business, listed company has tigther dateline to meet. As such, the audit team work on a listed company have to struggling between the dateline and the complexity of the transactions. This has resulted in the increase in hours required to spend.

Listed parent company would normally requires its oversea subsidiary to engage the same auditor as the parent company or at least a big 4 auditor. The Multinational Company located in oversea has tight reporting dateline too. Due to the fact that the parent might be a listed company in United States/ Europe, and subsidiary is required to report to the parent company on time, in order to meet the regulatory dateline.

The above analysis tell you why auditors in Big 4 needs to work so late.

#64 Introduction to Auditing

What is auditing? More specifically, what is financial auditing?

In big corporate entities ( Multinational- Companies, listed companies), small-to-meidum businesses, sole proprietor,etc, the entities are, required by law, to keep accounting records of the business on a timely basis. Hence, the entities hire accountants to keep the accounting records, that reflect the day-to-day business acitivities of the Company, as well as financial position of the Company.

The financial results are summarized and presented in what we called: Statutory Account ( Financial Statements/ Annual report for listed Company). How do we ensure that the financial results presented are accurate?

The auditors, independent party, are engaged to audit the financial results prepared by the entities. The auditors provide an independent check on the accounting policies, method of estimation, mathematical accuracy on the financial results presented.

The tasks are not as easy as other people would thought, as auditing involve a lot of professional judgement to ensure that the accounting policies adopted are not materially deviated from the local financial reporting standard.

In short, auditing provide and independent check on the financial results, and publish an opinion on the financial results of the entity: to give opinion on if the financial results are fairly stated.

#63 Impact of client's Key Performance Indicator on audit

During current credit crunch climate, auditors must be aware and gain an understanding of the management's Key Performance Indicator, as it represents the risky areas, where the management is likely to manipulate the results in order to meet the Key Performance Indicator.

Meeting a Key Performance Indicator means that the management might receive higher remunerations / incentive, and the jobs are highly secured with low risk of being retrenched.

#62 Deliveries without Billings

In construction industry and service industry (that involved installation service), there are instances that goods are delivered to customer, while billings have not been done. Can the Company, who delivered the goods, recognize revenue upon deliveries of the goods? Can the Company recognize revenue even if the installation services have not been done?

It depends on the term of the contract. In industry norm, the deliveries of goods to client’s location do not constitute a probable ground to recognize revenue.

Then, how should we record the goods delivered to client’s location?

The answer is: the items delivered are stocks in nature. As such, it should be recorded as part of the inventory recorded in the Company’s balance sheet.

#61- Stock Take Procedure 4

Proper segregation of duties must exist during stocktake.

As an auditor, we need to observe that the stock take team consist of:
1) Counter (Warehouse personnel)
2) Checker (Staffs from department other than warehouse department)

Warehouse personnels are the people who has direct access to the Company's stocks. Why should the warehouse personnel (counter) accompanied with a checker during stock take? This is to prevent potential fraud case and observe the normal inventory management procedures of the client. Warehouse personnel are the people who has day-to-day access to the warehouse. Assuming, they steal one and reported one stock lesser during stock take, nobody will not realize the fraud case, unless the inventory system capture the daily movement.

To illustrate with an example. Company XYZ does not has proper inventory system that keep track on goods in and goods issued. The Company will not know the exact quantity of the inventory item, until the physical stock take, which is done on a monthly basis. The employee could have just steal one item and without letting people realize.

Hence, stock take team must consist of at least one people from other department to check that the quantity counted and reported is as what have been counted physically.

#60 Implication of Internal Control- Impact of Credit Crunch on New Customers

In the current environment, where credit crunch impacts are prevailing, there are increasing credit risks of the Company. With the eagerness to obtain new customers, the strict credit risk assessments ( of new customers) should not be compromised.

The entity ( that are directly and severely affected by the credit crunch) should evaluate creditworthiness of new customers cautiously. Complete information needed to be obtained, for instance:
- Financial results of the Company
- Inquiries with market peers/ industrial person
- Shareholders' fund of the Company
- Reasons for purchasing from the entity

The entity can discuss with the new customer on the reason to purchase from them, as the supplies customer might have been discontinued from other supplies, due to credit risk concern.

Hence, a complete understanding and proper approval process need to be undertaken to prevent doubtful debt issue.

#59 Accounting treatment for bad debt provision

What would be the accounting entries while the collectibility receivable from a customer is deemed to be in doubt:

Dr. Bad Debt Expense (P/L)
Cr. Provision for Doubtful Debt (B/S)
Being provision for doubtful debt on receivable from XYZ

Provision for doubtful debt (B/S) relates to a contra account to Account Receivable. As such, the provision amount will be off-set against Account Receivable. Whereas, bad debt expense is generally classified as administrative expense in Profit & Loss statement.

#58 Inter-company Confirmation (cont'd)

If there are balances cannot be reconciled properly, while the difference are not material / not significant to the Financial Statement. The balance can be 'dumped' into trade receivable/ trade payable a/c balance. This is because, amount due from / amount due to inter-company should be nil at Group level Financial Statement.

Un-reconciled inter-company balance can result in inter-company balance not fully eliminated. In practice, the un-reconciled would be written off or classified as trade receivable/ payable (while the difference is not material) to the Group account.

#57 Fixed Asset Acquisition

What are the accounting entries for fixed asset acquisition:

Dr. Fixed Asset
Cr. Cash / Creditors
( Being fixed asset purchased)

What if the fixed asset acquisition is financed via Hire Purchase, what would be the entries then:

D. Fixed Asset
Cr. Creditors

Dr. Creditors
Cr. Hire Purchase Liability

#56 Inter-company confirmation

Intercompany confirmation have to be sent out to respective inter-company in order to confirm the outstanding balance due from/ due to inter-company. Discrepancies have to be reconciled immediately.

Discrepancies on inter-company balance could impact the Group figure during group consolidation. To illustrate, difference on inter-company balance on respective inter-company's book could resulted in inter-company balance not fully eliminated at Group level. If the discrepancies are significant, the Group account is likely to be eliminated.

Hence, it is important to ensure that inter-company balances are reconciled properly.

#55 Unrecorded Liabilities

Generally, unrecorded liabilities could be due to:

- Timing difference
- Management's intention do delay the recognition of liabilities
- Management not aware of the liabilities

Hence, a nencessary steps need to be taken to ensure the completeness of liabilities.

#54 Credit Crunch- Implication of Impairment on Machinery

The economy is slowing down and hit heavily by the current credit crunch crisis. What would be the implication on our auditing?

Based on the prevailing research and information, manufacturing sector is likely to be affected severely. For instance, there might be cancelled sales orders. This would leave some of the machines or fixed assets of the Company become idle. Utilisation rate of the machinery is likely to drop tremendously.

The lower utilisation rate has implication on impairment of machinery, given that some of the machineries will be idle and not involved in generating cash flow to the Company. Non-cash generating unit is an indication on impairment. Because, return on asset ( i.e. machinery) is almost nil in idle condition.

#53- General Provision on Doubtful Debt

In some instances, general provision for doubtful debt is provided for accoridng to the age of the outstanding debt. However, General provision for doubtful receivable is no longer allowed subsequent to the implementation of IAS 39.

IAS 39 states that:

“A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated.”

As such, impairment loss should be recognized when, subsequent to the initial recognition of the receivable, an event has happened which causes the receivable to be impaired. General provision provided according to age of the outstanding is no longer allowed. A financial asset should be impaired if, and only if, there is objective evidence of impairment.

#52 Tax Refund

What are the accounting entries for tax refund?

Dr. Cash
Cr. Provision for Taxation (B/S)
Being recognition of tax refund receipt

Dr. Provision for Taxation
Cr. Taxation Expense (P/L)
Being recognition of tax refund in Profit & Loss statement (upon finalization of YA)

As noted above, a tax refund is offset against the taxation recorded in P/L ( as evident from crediting taxation). Be noted that, a tax refund is potential indicating that the tax computation is at its final stage ( more or less finalized). Hence, any excess provision with respect to the particular Year of Assessment should be re-assessed / reversed out accordingly.

Hedge Fund Accounting Software

Disclaimer: this is not an advertorial thread

We came across a very powerful hedge fund accounting software, whereby all the computations are computed automatically, including analysis report, graph, charts, internal reporting purpose. The advanced technology avaialable in the market has resulted in the substantial change in the role of accountant, espeically fund accountant.

Hedge fund is a high-end area, where sophisticated accounting software have been developed to make the accounting process easier and faster. Imagine this: by inputing the details (e.g. share price), the reports, charts, entries are automatically generated.

However, a hedge accounting software should not disable a fund accountant ability to understand the concept, the journal entries, the accounting framework, and the relevant accounting standard, espeically IAS 39.

#51- Bank Reconciliation

Is bank reconciliation prepared by an account executive considered a control in the financial preparation process?

The answer to this question is very ambiguous. As there are risk that Account Executive set aside one balancing figure, in order to tally the total reconciling items. Hence, preparation of bank reconcilition itself does not form part of the control. However, if there are a superior review the bank reconciliation prepared, the above-mentioned risks can be mitigated.

Hence, reviewing bank reconciliation is considered a control.

# Auditing Tools

Someone ask me a question over the tea-break:

" What are the common software used by auditors?"

No doubts, the answer is spreadsheet ( e.g. Microsoft Excel) and text documents ( e.g. Microsoft Words). Thanks to the fabulous spreadsheet function contructed by the programmers. If not, I can't imagine the time you need to spend when you need to cast more than 100 balances.

To illustrate further, some of the audit firms have developed their own auditing software, which was used for their audit engagements. Everything was properly linked up (e.g. associate risk to an account assertion) in the software application. In our opinion, the software helps to develop and strengthen the auditing concept if efforts have been spent on understand the audit concept.

For instance, Ernst & Young has developed its auditing & assurance tools, GAMx for its audit engagement, as described in Ernst & Young Website

http://www.ey.com/global/content.nsf/International/Assurance_-_Tools_and_Resources

#50- Search for Unrecorded Liabilities (Post 2)

A search for unrecorded liabilites is to check for the completeness of the information disclosed by management / balances disclosed on the management account. However, the work is always the trickiest and toughest. A substantial amount of informations are required to fulfill the audit's satisfactory level.

How can we ensure completeness of contingent liabilities?

- Inquire with management on the status of the on-going project, analyzed the circumstances and identify potential commitments and contingencies which might have been made by managment, but not disclosed.

- Sending bank confirmation to obtain external evidence on potential bills payable, letter of credit, etc.

- Examine all the agreements of the Company to identify potential liabilities, such as: corporate guarantee given to bank for guarantee over subsidiaries' loan.

- Examine minutes & resolutions to identify on-going activities which might require commitments and contingencies

#49- Impairment on Property

We received the following query from our reader:

".. other than an independent valuation, what other alternative method can we use to test for impairment on property.."

Before we proceed to answer the following question, let's assume that the property above relates to building, land or any other commercial related building employed by the Company in the course of doing ordinary busines..

To answer your question, if the property is involved in the ordinary course of business ( e.g. shophouse where a business do its trading), then the alternative method includes:
1) Discounted Cash Flow Analysis
2) Profitability forecast for the next 5 years
3) Obtained market price of the similar property in the area nearby

To elaborate on point 1 and 2 above, if the business is able to generate sufficient cash flow and be in profit position. The auditor can conclude that there is no indcation of impairment on the property. As the asset employed is sufficient to sustain the business operations of the Company, and hence no impairment.

Besides that, the auditor could obtained the last transation price of the similar property in nearby area to compare the market price to book value of the property, in order to assess the existence of indication of impairment.

Announcement: Launching of SME Blog

Announcement:

Dear Auditing & Accounting Blog readers, we would like to, formally, announce the launching of our sister's blog:

Small and Medium Enterprises Blog @ the following URL:

http://mysme.blogspot.com

After countering numerous Small and Medium Enterprises, and meeting with all the SME' market leader, we would like to share our expertise in discussing contermporary issues facing SMEs in the global market. SMEs play a vital role in contributing the business growth of the global, and it should not be ignored. Hence, the SME blog is launched to share our expertise in SME.

Please visit the blog and leave some comment to us at: mysmeblog@gmail.com

Thanks.

Sex in Auditing & Accounting Industry

Let's make a guess on which is the majority sex group ( male / female) in auditing industry?

From an overall perspective, the majority of sex group tends to be female. This is consistent with the circumstances of more females are studying accounting degree.

However, examination of sex group at executive level ( in the auditing / accounting industry) reveals that the % of male start increasing. Probably, due to family commitments/ hectic working style, the female decided to left the industry.

Singapore Job Market

After enjoying years of economy europhia, the financial market collapse of Lehman Brother, Merrill Lynch and Bear Sterns are spilled-over and affecting the current Singapore job market.

The labour supply is definitedly more than the labour demand, and the job market turn to be extermely competitive. Some of the foreign banks are retrenching their staffs, and resulted in the increase number of people in labour supply pool.

Hence, it is extremely not easy to land a job immediately. Will accountant job be affected ? Definitely. There are accoutants in the bank too. If they got retrenched from the bank, they might join the commercial line.

# Auditor Joke

#1
What do you call an accountant without a functional spreadsheet?
Lost

#2
What would Economics be without assumptions?
Accounting.

#48- Internal Control of Small Companies

The Accounting & Auditing blog found an interesting findings on small companies' internal control on the website. Plz follow the link from CFO.com:
http://www.cfo.com/article.cfm/12202253?f=home_featured
( Note: pasting the link in this blog is not intended to infringe the copyright of CFO.com, but to share the knowledge with the blog' reader)
Small companies always struggling in the designation and implementation of internal controls due to:
- high cost involving in initiating internal control
- high monitoring and implementation costs
- time-consuming
- insufficient personnel
- unfavorable cost vs benefit analysis
The benefits brought from implementing internal control by the small companies is always lesser than the costs. And yet, internal control is considered the foundation and fundamental for future organic growth.

#47- Arms Length Transactions

Let's illustrate transfer pricing issue among 2 inter-company within the same Group.
Company A is incorporated in British Virgin Island and is not subject to tax.
Company B, which is Company A's subsidiary incorporated in USA, and is subjected to USA corporate tax.

Company B is making profit this financial year, and has a taxable profit of US$100million subjected to USA corporate tax. Company A might illegally 'transfer' the taxable profit of Company B to Company A, who is residing as a tax heaven, where no tax is payable on profits earned. To illustrate, Company A might charge Company B a lump sum of 'management fees', 'IT support fees' 'royalty fees', etc and resulted in the decrease in Company B' taxable profit.

Hence, while performing audit, we need to be aware of the nature of the inter-company transactions, and to test that the transactions are within arms length (it often requires expert to perform arms length test). This is to counter strike the transfer pricing issues mentioned above.

#46- Disadvantage of Hedge Accounting

Implementation of hedge accounting is aimed to reduce the earning volatility of the Company and to comply with the matching of the principle. However, there are some disadvantages in associated with Hedge Accounting:
- the hedge relationship has to be highly effective in order to qualify for hedge accounting
- high monitoring costs incurred from closely and constant moniotoring
- high documentation costs ( substantive documentations are required to support the hedge)
These factors are discouraging the Company from adopting hedge accounting.

#45- Timing of accruing expenses

We got the following query from the reader:

" ...Could you please tell me when the accrued expenses should be accounted for in system (AP)? is it at the beginning of each month? and once accounted should it be reversed immdiately after entering the corresponding expense for the accrual or should it be done in one go at the end of each month"

Before answering the question, we need to find out the nature of accruals, which is:
- to account for service received but billing not received from suppliers
- to account for expenses incurred ( e.g. montly provision for bonus)

Hence, practially, accruing for expenses should be done at the end of each month while doing month end closing. Yes, the amount should be reversed out immediately upon receiving the billing / payout the expenses. To illustrate with the following example:
Company XYZ has received repair & maintenance services from a service provider. The service amount has been agreed at US$500. However, at the end of the month, no billing has been received and the following entry have to be passed:
Dr. Repair Expenses
Cr. Accrued Expenses

Upon receiving the billing from service provider, the following entry should be passed to reverse the accruals:
Dr. Accrued Expenses
Cr. Trade Creditors

#44 Lower of Cost or Net Realizable Value

We received an email from our blog reader with respect to the valuation of inventory.

Should inventory be valued at

(I) Lower of cost or Net Realizable Value
or
(II) Lower of cost and Net Realizable Value

What is your answer then ? (I) or (II)?

Let's explain the question by using a sample, assuming Mobile phone distributor bought 10 pcs of iPhone at USD $ 150, and the selling price per pcs are USD $ 200. Should the inventory valued at USD $ 150 per pcs or USD $ 200 per pcs?

Before answering the questions, let's find out the meaning of 'Net Realizable Value'. 'Net Relizable Value' represents the amount 'realized'/ 'received' in an open market upon selling the goods. Hence, it is the selling price of the goods.

In this case, note (II) appears to be in conflict, as we can't valued the cost at USD $150 AND USD $ 200 at the same time. However, we should valued the iPhone at lower of cost or net realizable value, which is USD $ 150 per pcs.

#43- Trade Creditors confirmation

We received a questions from our blog reader with respect to the trade creditors' confirmation, as the following:

"... I realised one of my client have many creditors. And most balances are very healthy with 0 balance at year end. Their transactions is quite material ranging from RM300,000 to RM500,000 mostly. Do I need to send confirmations to these 0 balances too or just pick randomly. Thanks lots! :).."

The purpose of sending trade creditors confirmation is to obtain external evidence that the risk of liabilities not recorded are minimal. Although all the trade creditors might appear to be material, some of the balances might be made up of one single transactions and the volume of trading might be low.

Hence, to answer your queries, trade creditors confirmation should be sent to 'Major' trade creditors, with whom the Company has high volume of transactions. Amount might be immaterial as at the balance sheet date, due to recent repayment before year end. However, the risk of liabilities not recorded are usually associated with trade creditors, with whom the Company has high volume of transactions.

Besides, you could rely on statement of accounts forwarded from suppliers as an external evidence.

#42 High risk account assertion for High-end fashion industry

We received an email from one of our reader asking the following question: what will be the high risk area of the high-end fashion retail industry (i.e. which account assertion has the high risk).

To answer your question in brief before proceeding to detail analysis:

Inventory- Measurement/ Valuation, Provision for Stocks- Completeness, Valuation

In high-end fashion industry, the products are unique and the inventory turnover rate is relatively low for some of the items. For instance, a US$500,000 watch might take more than one year to market the products to end-user.

How can we assess the inventory particularly for low inventory turnover then? We request the management to classify the products into different classes of inventory, and we assess the historical sales trend of that particular class to develop and understanding of the client’s inventory. Herein, the in-depth understanding of the stocks provides a reasonable ground to assess the provision for stocks as at today.

Also, we checked to subsequent sales to check if the stocks have been subsequently sold after year end to assess that the inventory have been sold at a selling cost at least above its cost. We have to check that the inventories are valued at ‘lower of cost or net realizable value’.

#41 Recap of roles of different people in Accounting

Bookkeepers keep the Accounting Book (day-to-day normal Account Receivable/ Account Payable entries)
Accountant review the work done by bookkeepers and prepare non-recurring journal (e.g. provision for doubtful debt)
Financial controller reviews the work done by Accountant and oversees the financial statement.
CFO oversees and monitors the finance function and ensures the smooth flow of company’s financing.

#40 Audit for Inventory Valuation

As mentioned in post #39, stocks should be valued at lower of its cost or net realizable value. This has posted a imperative audit work step: to ascertain that the respective items is value at cost or net realizable value (Note: each Respective items have to be valued at cost or net realizable value).

How do we ensure that the stocks are valued properly?

1. Randomly selected a certain number from inventory listing.
2. To find out the most recent sales/ subsequent sales after year end. (general guide: 3 months)
3. From the invoices, noted down selling price.
4. Compare the selling price to the actual cost of the sample.
5. Cost > Selling Price, valued at selling price
Selling Price > Cost, valued at cost.

#39 Inventory Valuation (anwer to #38)

Inventory items have to be revalued at ‘lower of cost or net realizable value’. Practically, net realizable value means the amount at which the Company could sell in an open market (selling price).

To answer the question post in #38

1) Value at cost of $2.00. ( as cost of $2.00 is lower than its net realizable value of $2.50)
2) Value at Net realizable value of $1.50 ( as cost of $1.50 is lower than its cost of $2.00)

#38 Accounting for Discount on Prompt Payment

The accounting for prompt payment discounts depends on the nature of the discount. If the prompt payment discount is effectively part of normal trade rebates, i.e. generally everyone receives them, whether they pay promptly or not, they should be accounted as a deduction from the cost of inventory rather than as finance income.

#38 Inventory valuation

As at balance sheet date, client need to value its stocks. Assuming Client ABC has only one stock, Product Y on hand.
Let's consider the following different circumstances, ( assuming balance sheet date is 31 Dec 2007)

1) Client ABC bought Product Y at US$ 2.00 in Aug 2007. They sold Product Y at US$ 2.50 in Dec 2007. How should the client value the stocks ? Should the company use cost or realizable value ( its selling price) to value the stocks?

2) Client ABC bought Product Y at US$2.00 in Aug 2007. The client priced Product Y at US$2.50 and they are unable to sell any single stocks. Hence, the management decided to give discount and sell the stocks at US$1.50 in Dec 2007. How should the client value the stocks? Should the company use cost or realiable value (its selling price) to value the stocks.
[ Refer to next posting coming up for answer]

#37 Stock Take Audit Procedure 3

Things to pay attention to by auditor during stock take:

- to walk around the warehouse / factory to observe if there is any physically impaired/ damaged items.
- if the items are damaged, to check if these damaged items are included i stock listing (if yes, then request client to write off the inventory items)
- to check if the damaged items are properly segregated, as the client might put the damaged item in along with normal goods and resulted in overstatement of inventory.
- if the items appeared to be dusty, check with client if the items are saleable. ( potential provisoin for inventory issue).

Rule of thumb: to observe the physical condition of stocks and report any stock obsolescence.

#36 Stock Take Audit Procedure - 2

As mentioned in previous posting ( Post #35), test count samples in stock take need to be selected: 1) from the floor and 2) from the list.

The purpose of selecting samples from the floor means select the samples from the warehouse floor, test count the result then match to inventory listing as at balance sheet date, to check that the stock listing is complete.

The purpose of selecting samples from the list means select the samples from the list, to check that the inventory appear on the list exist.

#35 Stock Take in Audit Procedure

Purpose of stock take is to verify the existence of the inventory accounted by the company. Procedures in stock take:

1. Obtain stock listing as at balance sheet date from client.
2. Randomly select certain number of samples from stock listing to physically count the inventory to check that the inventory listing ( as prepared by client) has no material difference.
3. Randomly select certain number of samples from the floor ( and test count the number of the items) to check that the stock listing is complete.
4. Make any adjustment if necessary.

#34 Accounting for Fixed Asset written off

When the Company decide to write off the fixed asset, the following entries will be passed:

Dr. Accumulated Depreciation
Dr. Loss on Asset written off (if any)
Cr. Fixed Asset ( at cost)

The company would write off the fixed asset in the following circumstances:

1) The company may write off the fixed asset, if the assets are no longer in feasible use.
2) The fixed assets have been fully depreciated.

In case 1 above, the company might incurred a loss on fixed asset written down if the net book value is > nil. Whereas, when the assets have been fully depreciated ( as in case 2), no losses will be incurred upon written off.

#33 Risk-based audit 2

One of the argument for risk-based audit is: it is more cost efficient to focus on the risky area, rather than the traditional way. The traditional 'bottom-up' approach test almost all the details of the business, and almost every aspect of the businesses are covered (audited).

Whereas, the risk-based only focus on the risky area identified by the auditors.

#32 Accounting for Rental Deposit

A rental deposit is usually required to be paid when a company rents a premise from the landlord. These rental deposits are either refundable at the end of the lease period or will be used to offset against the last few months rental payments. Rental deposits are usually not material to the financial statements. However, for companies in the property or retail industry, the rental deposits received or paid may be significant.

The rental deposit is a financial instrument (i.e. a financial asset to the lessee and a financial liability to the lessor) and should be accounted for under FRS 39. The rental deposit should be recognised at fair value on initial recognition, and the difference between the fair value and the amount paid is carried on the balance sheet as a deferred lease expense/income and recognised as lease expense/income on a straight line basis over the lease term. Interest income/expense is recognised over the lease term as the carrying value of the rental deposit is accreted to the nominal value.

#31 Weakness of Risk-based audit 1

Nowadays, the audit firms, including the Big 4 in the world adopt an top-down audit approach, so called 'Risk- based audit'. The deemed high risk areas (account) are the focus of the auditors ? Only minimal work will be done for the less-risky area.

However, the problem is auditors are the one who use the professional judgement to justify what area are risky. And, auditors might fail to identify the risky area of the business. Hence, no works were done for the risky area of the business!