In this session, I will discuss auditing for expense and income account.
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The audit of income and expense accounts is directly related to the balance sheet and is not a separate part of the audit process. A misstatement of an income statement account almost always equally affects a balance sheet account, and vice versa. As we have discussed in preceding chapters, the audit of income and expense accounts is intertwined with the other parts of the audit. We provide a brief description of these tests here as a review of material covered in earlier chapters

Substantive analytical procedures
Tests of controls and substantive tests of transactions
Tests of details of account balances
Our emphasis here is on income and expense accounts directly related to the acquisition and payment cycle, but the same concepts apply to the income statement accounts in all other cycles.
Tests of Controls and Substantive Tests of Transactions

Both tests of controls and substantive tests of transactions have the effect of simultaneously verifying balance sheet and income statement accounts. For example, assume an auditor concludes that internal controls are adequate to provide reasonable assurance that transactions in the acquisitions journal occurred and are accurately recorded, correctly classified, and recorded in a timely manner. By doing so, the auditor obtains evidence about the correctness of individual balance sheet accounts, such as accounts payable and fixed assets, and income statement accounts, such as advertising and repairs. Conversely, inadequate controls and misstatements discovered through tests of controls and substantive tests of transactions indicate the likelihood of misstatements in both the income statement and the balance sheet.

The most important means of verifying many of the income statement accounts in each transaction cycle are understanding internal control and performing the related tests of controls and substantive tests of transactions. For example, if the auditor concludes after adequate tests that control risk can be appropriately assessed as low for transactions in the acquisition and payment cycle, the only additional verification of related income statement accounts, such as utilities, advertising, and purchases, will occur through the performance of substantive analytical procedures and cutoff tests. However, certain income and expense accounts are not verified at all by tests of controls and substantive tests of transactions, and others must be tested more extensively by other substantive testing. These are discussed next.

Tests of Details of Account Balances—Expense Analysis

Auditors must analyze the amounts included in certain income statement accounts even though the previously mentioned tests have been performed.

Expense account analysis involves auditor examination of underlying documentation of individual transactions and amounts making up the detail of the total of an expense account. The documents are the same type as those used for examining transactions as part of tests of acquisition transactions, including invoices, receiving reports, purchase orders, and contracts.

Although the focus of expense account analysis is on transactions, these tests differ from tests of controls and substantive tests of transactions. The tests of controls and substantive tests of transactions are meant to assess control risk. As such, they are tests of classes of transactions, such as acquisitions, and therefore include many different accounts. In the analysis of expense and other income statement accounts, the auditor verifies transactions in specific accounts to determine whether the transactions are appropriate for the client, properly classified, and accurately recorded.



Repairs and maintenance expense accounts to determine whether they erroneously include property, plant, and equipment transactions
Rent and lease expenses to determine the need to capitalize leases
Legal expense to determine whether there are potential contingent liabilities, disputes, illegal acts, or other legal issues that may affect the financial statements
Utilities, travel expense, and advertising accounts are rarely analyzed unless substantive analytical procedures indicate high potential for material misstatement.