Accrued expenses are expenses that have been incurred but have not yet been recorded in the financial statements. In accounting, they are recognized as liabilities on the balance sheet. Accrued expenses are also known as accruals.
Under Generally Accepted Accounting Principles (GAAP), accruals are recognized when the liability has been incurred and can be reliably estimated, even if the payment has not yet been made or invoiced. This means that the liability has been incurred, but the invoice has not yet been received or the cash payment has not yet been made.
Audit Risks of Accrued Expenses
Accrued expenses are a common area of concern for auditors due to their inherent subjectivity. The following are some of the key audit risks associated with accrued expenses:
- Misclassification of Accrued Expenses: Accrued expenses may be classified incorrectly as either expenses or liabilities, resulting in an overstated or understated balance sheet.
- Estimation Errors: Accrued expenses are often estimated, which increases the risk of errors in their recognition and measurement.
- Improper Recording: Accrued expenses may not be recorded in a timely or accurate manner, which can result in incorrect financial statements.
- Unsupported Accruals: Accruals may be made without adequate documentation or support, which increases the risk of incorrect recognition and measurement.
Audit Assertions for Accrued Expenses
Audit assertions are the representations made by management about the financial statements. In auditing accrued expenses, the following audit assertions should be considered:
- Existence: Accrued expenses exist and have been recorded in the financial statements.
- Completeness: All accrued expenses have been recorded in the financial statements and no material amounts have been omitted.
- Accuracy: Accrued expenses have been recorded with the correct amount and are accurate in their presentation.
- Classification: Accrued expenses have been properly classified as liabilities in the balance sheet.
Audit Procedures for Accrued Expenses
The following audit procedures should be performed to assess the accuracy and completeness of accrued expenses:
- Review of accounting records and support for accruals: The auditor should review the accounting records and supporting documentation to ensure that all accruals have been properly recorded and supported.
- Review of transactions: The auditor should review transactions and other documentation related to accrued expenses to ensure that they have been recorded accurately.
- Test of details: The auditor should perform a test of details on a sample of accruals to verify the accuracy of the amount recorded and to ensure that the liability has been incurred.
- Comparison to prior periods: The auditor should compare the current period’s accruals to the prior period’s accruals to identify any unusual fluctuations or trends.
- Confirmations: The auditor may request confirmations from suppliers or other third parties to verify the accuracy of accruals.
These audit procedures will help the auditor to identify any misstatements or errors in the recognition, measurement, and presentation of accrued expenses in the financial statements.