Question for auditors- do you all factor in inflation while doing sales analysis

We have one question that we want to hear from our fellow followers and readers of accounting and auditing blogs. As part of audit procedures for most of audit firms, it is compulsory to review and understand the fluctuation of certain accounts, for instance your sales revenue.

We would like to understand from you, do you all factor in inflationary rate while factor in the review of income statement, e.g. sales revenue, operating expenses, etc? To illustrate, your expenses level may stay relatively constant at prior period level. However, given the inflatinonary rate of 5%, should the expenses be higher, assuming volume stay constant??

We would like to hear from you on whether did you factor in the inflationary factor, and how did you address that. Thank you very much.

Something interesting: Warren buffet's comments on goodwill

Just want to share with you some interesting comments by Warren Buffet, a promoninent value investor relating to goodwill.

" ... $15.5illion of goodwill that is attributable to our insurance companies and inlcuded in book value as an asset. In effect, this goodwill represents the price we paid for the float-generating capabilities of our insurance operations. The cost of the goodwill, however, has no bearing on its true value, For example, if an insurance sustain large and prolonged underwriting losses, any goodwill carried on the books should be deemed valueless, whether its original cost" (Extracted from Berkshire Hathway- Letter by Warrent Buffet to the shareholders- 2012"

What Warrent Buffet commented is true from a commercial perspective. Goodwill represents the premium a company paid for in an acquisition. The true value on the book could be higher than its book value. If management opined that the true value of the goodwill is lesser than its book value, then the goodwill need to be written down to its recoverable amount. For a company in sustained losses position, it is no easy to proof that no impairment is required for this goodwill.

As a result, as a auditor, we need to perform thorough review on the impairment assessment of goodwill instituted by management.

To our Accounting & Auditing blog readers

Dear all,

We would like to thank you for the supports you have given to us in the past. We are very proud that the followers of our blog has been increasing gradually over the past few years from nil to approximately 125. Given the fact that accounting and auditing is a rather niche area, we have no complaints.

Nevertheless, we would like to remind our readers that: please feel free to drop us email at myauditing@gmail.com if you have any questions relating to accounting and auditing issues, client-related matters, career advancements, university-related questions. We will try out best to answer the concerns you posted to us.

Again, thank you very much for your support in the past.

Review of petty cash amount- potential financial loss

As an auditor, we should also review the reasonableness of petty cash amount held by individual. Petty cash are generally held by invidiual (usually employees of a company) for disbursement of daily expenses / urgent payment when necessary.

Nevertheless, an individual shall not hold petty cash amount far exceeded the amounts required. This is because there is potential risk that individual may mis-appropriate the funds and resulted in financial loss to the Company.

As a result, management should exercise control to review the budgeted petty cash outflow for the month and furnish this petty cash to the person in-charge. It is not ideal for the Company to disburse significant cash amount to an individual. The Company can always top-up the petty cash amount when requested.

Audit clients with presence in China and Malaysia

Some of our audit clients may have subsidiaries in overseas, e.g. China and Malaysia.

If your audit clients have presence in China and Malaysia, pelase take note that there is a increase in minium wages in certain provinces of China and the entire Malaysia. The minium wages differ among differnt provinces in China. It is important for you as auditor to find out the actual minimum wages rate for the particular regions where you audit client has presence. For Malaysia, the minium wages has increased to RM 900.

It is important to form an expectation that the salary costs are expected to increase in FY 2012, if your audit clients have presence in the countries mentioned above.

Disclosure of the source of deferred tax assets and liabilities

Our audit client may have recorded deferred tax assets and liabilities on its balance sheet/ statement of financial position. Deferred tax is essentially the tax impact arising from the temporary difference between the Company's accounting and tax carrying value. For instance, the net book value of a property-plant and equipments are usually different between accounting book and tax book. This could be because the depreciation policy for accounting book ( i.e. set by the Company) and tax book (i.e. set by the authority) is different.

In reviewing the financial statement of our audit clients, who has recorded the deferred tax, we need to ensure that the Company has disclosed the source of the deferred tax assets / liabilities. This helps the financial statement users to understand the nature of the deferred tax assets / liabilities.

Generally, deferred tax assets are mainly attributable to:
- recognition of unutilised tax losses
- recognition of unabsorbed capital allowance
- differences on depreciation

Whereas, deferred tax liabilities are attributable to:
- differences on depreciation
- differences on provision

By disclosing the source of deferred taxes, the financial statement users can understand the balance sheet, as well as the tax expense of the Company.

Provision for restoration cost/ provision for reinstatement cost

When an audit client signed an rental / lease agreement to lease a space (i.e. office / warehouse), please make sure that we, as an auditor, we review the agreement thoroughly.

Generally, audit client has to reinstate/ restore the lease space to its original state. To illustrate, audit client may have renovated the building for its own purpose. The owner would request the audit client to reinstate the lease space to its original state when the lease expire and the audit client decided not to renew the lease agreement.

A provision for instatement cost / restoration cost need to be recorded, as it is an existing obligation of the audit client. This amount relates to the cost to be incurred to reinstate the lease space back to its original state. This amount can be estimated by obtaining quotation from the renovator / building contractor.

The accounting entries are:
Dr. Fixed asset- reinstatement cost
Cr. Accrual

The amount capitalised above relates to the full cost to be incurred when the lease expire ( note: assume the inflationary adjustment to be not material. On an annual basis, the following entry need to be recorded:

Dr. Reinstatement cost- P&L
Cr. Accum Dep- Fixed asset- reinstatement cost
This amonut is computed based on the amount capitalised divided by remaining lease period.

The depreciation entry is to record the cost capitalised into P&L on a straight line basis.