Guidance Note On Audit Of Expenses
Para 2.1 of the "Preface to the Statements on Standard Auditing Practices" issued by the Institute of Chartered Accountants of India states that the "main function of the APC is to review the existing auditing practices in India and to develop Statements on Standard Auditing Practices (SAPs) so that these may be issued by the Council of the Institute." Para 2.4 of the Preface states that the "APC will issue Guidance Notes on the issues arising from the SAPs wherever necessary."
The Auditing Practices Committee has also taken up the task of reviewing the Statements on auditing matters issued prior to the formation of the Committee. It is intended to issue, in due course of time, SAPs or Guidance Notes, as appropriate, on the matters covered by such Statements which would then stand withdrawn. Accordingly, with the issuance of this Guidance Note on Audit of Expenses, paragraphs 11.2‑11.8 of Chapter 11 of the Statement on Auditing Practices, titled 'Profit and Loss Account', shall stand withdrawn. In due course of time, the entire Statement on Auditing Practices shall be withdrawn. The following is the text of the Guidance Note on "Audit of Expenses" issued by the Auditing Practices Committee of the Council of the Institute of Chartered Accountants of India. This Guidance Note should be read in conjunction with the Statements on Standard Auditing Practices issued by the Institute.
1. An expense is a cost relating to the operations of an accounting period or to the revenue earned during the period or the benefits of which do not extend beyond that period. The expression "cost" means the amount of expenditure incurred on or attributable to a specified article, product or activity.
2. Expenses are recognised by the following approaches:
(a) Identification with revenue transactions
Costs directly associated with the revenue recognised during the relevant period are considered as expenses and are charged to income for the period.
(b) Identification with a period of time
In many cases, although some costs may have conпїЅnection with the revenue for the period, the relationпїЅship is so indirect that it is impracticable to attempt to establish it. However, there is a clear identification with a period of time. 1 Such costs are regarded as 'period costs' and are expensed in the relevant period, e.g, salaries, telephone, travelling, depreciaпїЅtion on
office building, normal interest, etc. Similarly, the costs the benefits of which do not clearly extend beyond the accounting period are also charged as expenses.
3. The following features of expenses affect the nature, timing and extent of the related audit procedures:
(a) In the case of most items of expenses, documentary evidence originating from third parties is available.
(b) The nature and relative significance of various items of expenses usually differ from one enterprise to another, depending primarily on the nature of operaпїЅtions carried out by them. For example, in the case of most manufacturing enterprises, the principal items of expenses would include the cost of raw materials consumed, labour cost and other conversion costs. On the other hand in the case of a trading enterprise, the principal items of expenses would generally be the cost of goods sold. In the case of an enterprise supplying, providing, maintaining and operating any services, the principal items of expense would include personnel and professional expenses, office maintenance, etc.
(c) The amount of some expenses has a logical relationпїЅship with certain other financial statement items while the amount of some other expenses does not have such a relationship. For example, in an enterprise where the production process is standardised, the consumption of raw materials (and, therefore, the cost of raw materials consumed) has a logical relaпїЅtionship with the quantum of output. Similarly, the proportion of various constituents of cost of production is expected to remain more or less constant in the absence of known conditions to the contrary. Likewise, proportion of the amount of interest for a period to the amount of loans outstanding during the period is expected to vary within certain specific EmпїЅits. On the other hand, the expenditure on research and development often has little relationship with other items in the financial statements.
(d) The amount of some items of expenses (e.g. gratuity, taxes, bonus, etc.) is significantly affected by applicaпїЅble laws.
4. In an audit, the auditor employs appropriate procedures to obtain reasonable assurance about various assertions (see SAP 5, Audit Evidence). In carrying out an audit of expenses, the auditor is particularly concerned with obtainпїЅing sufficient appropriate audit evidence to corroborate the management's assertions regarding the following:
that recorded expenses arose from transactions or events which took place during the relevant period and pertain to the entity.