Required: Describe a complete audit program for collecting relevant evidence for the audit of the estimated warranty liability.
Approach: Develop specific assertions related to warranty liability based on the five principles.
Ans:
- Financial statement assertions are the representations of the directors that are embodied in the financial statements. By approving the financials statements, the directors are making representations about the information therein. These representations or assertions may be described in general terms in a number of ways.
- ISA 500 states the ‘the auditor should use assertions for classes of transactions, account balances, and presentation and disclosures in sufficient detail to form the basis for the assessment of risks of material misstatement and the design and performance of further procedures'.
- Following paragraphs describes the specific assertions related to warranty liability based on the five principles of quality of audit evidence i.e. External, Auditor, Entity, Written and Originals:
- External: Audit evidence from external sources is more reliable than that obtained from the entity's records. The assertions from outside sources about the warranty liability are the most factual and real and will be considered at high priority by the auditor.
- Auditor: Evidence obtained directly by auditors is more reliable than that obtained indirectly or by inference. The direct retrieval of information by the auditor from the management and those charged with governance will be more valid than from indirect resources.
- Entity: Evidence obtained from the entity's records is more reliable when related control system operates effectively. Next comes the order of entity records if there is strict internal control system operating in the environment.
- Written: Evidence in the form of documents (paper or electronic) or written representations are more reliable than oral representations. Everything in written is more valued than in verbal. Same is the case with warranty liability. If there exists documentary evidence, then that will be highly acceptable.
- Originals: Original documents are more realistic than photocopies, or facsimiles. If warranty liability original documents are present then it will be a valid proof of its existence and vice versa.