When we are auditing the income statement, one of the items that often draws our attention is Other Income. Other Income is basically an income that is not revenue, which means, not income generated directly from the sale of goods and services of the entity’s primary business operation itself.
There are multiple types of Other Income. Here we have listed out some common examples of Other Income:
- Interest income
- Rental income
- Gain from disposal of fixed assets or investments
- Foreign exchange gain (unrealized or realized)
- Dividend income
How an income can be classified as Other Income depends heavily on the nature of the entity’s business. It is important to note that a rental income could be the Other Income to a business selling developed property but it could be revenue to an entity in the real estate investment trust business.
Hence, the auditor must obtain a good understanding of the business of the entity that is being audited before performing the audit.
Before the auditors decide what procedures to perform, the risks associated with auditing Other Income should first be identified:
- Risk of Material Misstatement: The Risk of Material Misstatement could potentially arise from the timing of recognition where the Other Income could be recognised in the incorrect accounting period. Other than those, there is also a Risk of Material Misstatement due to deviation from the accounting standard due to practical issues. For example, rental income is supposed to be recognised on a straight-line basis but due to the way the rental agreement is structured, management may have recognised based on the timing of cash flow instead, resulting in a misstatement which could be material.
- Control Risk: Since Other Income is an item in the income statement, it has a direct effect on the bottom line, i.e., net profit figure. Control Risk for Other Income could be due to management overriding the controls to manipulate the profit figure. The risk is especially higher when the management’s pay is dependent on the performance of the entity.
- Detection Risk: Detection Risk is the risk that an auditor may not able to detect the material misstatements in the reported amounts of Other Income. This is because the auditor will perform testing on a sampling basis, which could lead to certain amounts of the Other Income that are not part of the samples selected being omitted during the audit. Material misstatements could sometimes be within such omitted items, thereby giving rise to Detection Risk. Detection Risk exists in all audits where tests are performed on a sampling basis.
The audit risk for Other Income is usually low since it can be easily verified most of the time and it often requires little to no judgement.
For an auditor to be reasonably assured of the Other Income balance, tests will be performed to cover the relevant audit assertions. The assertions applicable to Other Income are as follows:
- Occurrence: This assertion tests whether all Other Income transactions recorded in the financial statements actually exist, i.e., such income has actually been received by the entity.
- Completeness: The entity recognizes all Other Income that it received during the accounting period.
- Measurement: This concerns that Other Income on the income statement is correctly measured and without any misstatement that can materially change the final result of the financial statements.
- Presentation and Disclosure: The Other Income balance is correctly presented after the Gross Profit figure and before the Profit Before Tax figure in the Income Statement. Adequate disclosures related to Other Income should also be made based on the relevant accounting standards in the notes to the financial statements.
Audit Procedures for testing Other Income include Test of Controls and Substantive Tests.
Test of Controls:
On a general note, a Test of Controls is not very often performed for Other Income. This is because Other Income is generally not a routine income and some only arise under specific circumstances. In that case, not all entities being audited have an established control for it that auditors can perform a test on.
Besides, the control for Other Income could sometimes be an integral part of the control for another financial statement line item. For example, performing the Test of Control for fixed asset disposal would cover the control on calculating the gain of disposal of the fixed asset.
Substantive Audit Procedures for Other Income:
More often than not, higher reliance will be placed on Substantive Audit Procedures for Other Income:
1) Substantive Analytical Procedures:
Substantive Analytical Procedures include the consideration of whether any specific circumstances are arising that could result in the generation of Other Income. One example of this would be government aids. This will prompt the auditor to anticipate an increase in the Other Income balance and further investigation should be carried out if the expectation is not met.
We should also take note of changes in the balance sheet. For instance, the appearance of an investment in the balance sheet should signal the auditor to take note of any dividend income while a higher cash and bank balances would alert the auditor to anticipate a higher interest income.
Other than the above, if the entity in question has overseas dealings, we should also be wary of the movement in the exchange rate as it may potentially give rise to a realised or unrealised foreign exchange gain.
2) Test of Details for Other Income:
To test details for Other Income, audit procedures are designed around assertions. Example and description of test of details are given in the table below:
|Example of Audit Procedure
|Reviewing the bank statement to verify the receipt of such income.
|Reviewing all contracts and agreements that can give rise to an income to ensure all income has been recorded.
|Recalculate the income based on the agreement or other relevant supporting documents.
|Presentation and Disclosure
|Reviewing the financial statements prepared by the entity and identifying if information regarding Other Income has been sufficiently disclosed per the applicable accounting standard.