Auditing Interest Expenses – Risks, Assertions, And Audit Procedures

Overview

When auditors begin the audit planning phase, it is important for them to consider the fact that there are several different phases that are included in order to properly execute the auditing process. Therefore, it is important for auditors to ensure that they are able to factor in all the elements within the financial statements so that they have proper clarity regarding the tasks and objectives they need to fulfill so that they can duly ensure that all proper ground is covered in this aspect.

Interest Expenses tend to be one such protocol that needs to be taken very diligently by the auditors, because of the relative ambiguity it entails. In this regard, it can be seen that auditing interest expenses tends to be one of the most important courses of action, and therefore, requires auditors to properly plan the audit process in order to determine if interest expenses have been materially misstated or not.

Interest Expenses, also referred to as financial costs of the business, are the costs that a business incurs when it comes to financing-related issues. This is mentioned in the latter part of the Income Statement, after the Operating Income before Tax and Interest Expense has been computed. Since this is the amount that the company pays to the external stakeholders (creditors, or loan holders), it is important to conduct an audit to ensure that there have been no material misstatements.  

Risks Associated with Auditing Interest Expenses

There are several risks that are associated when it comes to auditing interest expenses. These risks are mentioned below:

  • Risk of Material Misstatement: The risk of Material Misstatement tends to be one of the most basic risks associated with interest expenses. This is the risk that interest expense has been materially overstated and understated in the financial statements, such that it makes a very prominent impact on the decision-making of the end-user. When it comes to interest rates, it can be seen that this particular risk is relatively low. This is because this can be easily verified via bank statements, as well as investment schedules and reports that are generated by the companies.  
  • Detection Risk: Detection Risk mainly comprises the inability of the auditors to point out the material misstatements in the reported amounts of interest expense. The detection risk, when it comes to interest expenses, is low to mediocre, because of the fact that disclosure pertaining to interest expense is normally easily reconcilable via other supporting documents.
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Therefore, it can be seen that the overall inherent risk of interest expenses is also mediocre to low. However, this cannot be overlooked upon by the auditors, and they still need to consider the fact that it is highly important to test all assertions with properly backed audit procedures so that reasonable assurance can be gained pertaining to the overall accuracy of the interest expenses.  

Audit Assertions when Auditing Interest Expenses

When auditing interest expenses, there are a couple of audit assertions that need to be kept in mind. These assertions are given below:

  1. Existence: The interest expense that is disclosed on the financial statement must actually be a legitimate expense. It cannot be a made-up expense, and therefore, only those expenses can be included in the financial statements that have actually occurred. Normally, interest expenses are incurred when there is a long-term financial loan drawn by the company, and there is a liability drawn on the company.
  2. Cut-Off: The interest expense that is mentioned on the Income Statement tends to be relevant for the particular year only. Interest Expense for the forthcoming year, or for the previous year cannot be deducted as an expense for the current year. Therefore, declaration of expenses for the respective financial year also tends to be an important part.
  3. Accuracy: Interest Expenses for the particular year should be included accurately in the financial statements. This implies that the interest charge for the particular year should be calculated. It should not be mixed up with the interest paid in the subsequent year.
  4. Completeness: All interest expenses should be mentioned on the financial statements with proper disclosure. All relevant information that might prove to be helpful to the end-user of the financial statement should be properly disclosed in the financial statement. As per this assertion, interest expenses should include a proper disclosure pertaining to all the instruments (as well as the relevant mathematical calculation) based on which the interest expense was drawn.  
  5. Understandability: Interest Expense that is mentioned on the Financial Statements should duly include all information that can ensure that the information is comprehendible to the end-user of the financial statements. The main premise here is to ensure that the users of the financial statements are able to understand why the company incurred the particular interest expense, and how was the relevant total of the tax computed by the accountants. This information should be easily available and understandable by the users of the financial statements.
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Audit Procedures during Auditing Interest Expenses

In order to test the assertions mentioned above, the audit procedures should be designed in order to enable auditors gather substantial evidence that can help them comment on the viability of the financial statements.

Audit AssertionSubstantive Testing
ExistenceIn order to test the assertion of existence, the following substantive tests are carried out: Reasonability of the interest expenses is checked. It should be ensured that the declared interest expenses are in line with the industry trends. It is to ensure that these expenses are not overwhelming, or out of the blue. There is also a need to ensure that interest expenses have already occurred. This is checked by verifying the investment schedules, and ensuring that the interest has actually been accrued on those particular loan schedules.
Cut-offIn order to check for the completeness of the interest expense that have been disclosed, the following substantive tests are carried out: There is a need to check loan schedules to check the interest payable for the current year, and if the correct amount of interest expense for the year has been charged.The auditors also need to design processes in order to verify that the interest expense for the relevant year has not been overlapped with the interest expense paid during the particular year.  
AccuracyThe assertion pertaining to interest expense pertains to two main things: checking for the correct balances in interest expense payable (or prepaid), and the current audit expense for the year. This is checked by recalculating the interest expenses, in order to ensure that there have been no mathematical errors and in computing the interest expense for the particular year. This also includes ensuring that all relevant totaling has been carried out in a proper manner. All the information should be properly disclosed in an accurate manner on the financial statement.
CompletenessThe audit assertion of completeness refers to ensuring that all interest expenses are properly mentioned in the financial statements. Therefore, the auditors need to ensure that all the information is properly mentioned in the financial statements. Basically, they need to confirm that all information that might be important or relevant to the stakeholders should be mentioned on the Notes to the Financial Statements. This also includes information regarding the different interest expenses paid (since there might be more than one loan taken on by the company).  
UnderstandabilityThe audit procedure that is designed to make sure that the disclosures to the financial statement are understandable and comprehendible, is to check if all the relevant disclosures are made in a manner which can be understood by the general public.  
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