Audit Focus: Journal Entries

Reminders

Understanding Controls Over Journal Entries

Auditors should understand an entity’s controls over initiating, authorizing, recording, and processing journal entries in the general ledger, subsidiary ledger, or other information technology (IT) systems.

The sources of journal entries and other adjustments may include manual or automated entries from subsidiary ledgers or other IT systems, as well as post-closing or top-side entries not yet reflected in the general ledger. Auditors should obtain an understanding of the design of controls over journal entries and other adjustments, both automated and manual, and determine whether they are suitably designed and have been placed into operation. It also is important for the auditor to consider whether control deficiencies exist where the auditor may need to adjust the nature, timing, and extent of their journal entry testing.

Identifying and Selecting Journal Entries To Test

Auditors should examine journal entries and other adjustments for evidence of possible material misstatement due to fraud.

The auditor should use professional judgment in determining the nature, timing, and extent of the testing of journal entries and other adjustments. For purposes of identifying and selecting specific journal entries and other adjustments for testing, and determining the appropriate method of examining the underlying support for the items selected, AS 2401.61 requires the auditor to consider:

• The engagement team's assessment of the fraud risk. The presence of fraud risk factors or other conditions may help the auditor to identify specific classes of journal entries for testing and indicate the extent of testing necessary.
• The effectiveness of controls that have been implemented over journal entries and other adjustments. Effective controls over the preparation and posting of journal entries and adjustments may affect the extent of substantive testing necessary, provided that the auditor has tested the controls.
• The entity's financial reporting process and the nature of the evidence that can be examined. The auditor's procedures for testing journal entries and other adjustments will vary based on the nature of the financial reporting process.
• The characteristics of fraudulent entries or adjustments. Inappropriate journal entries and other adjustments often have certain unique identifying characteristics. Such characteristics may include entries (a) made to unrelated, unusual, or seldom-used accounts, (b) made by individuals who typically do not make journal entries, (c) recorded at the end of the period or as post-closing entries that have little or no explanation or description, (d) made either before or during the preparation of the financial statements and that do not have account numbers, or (e) containing round numbers or a consistent ending number.
• The nature and complexity of the accounts. Inappropriate journal entries or adjustments may be applied to accounts that (a) contain transactions that are complex or unusual in nature, (b) contain significant estimates and period-end adjustments, (c) have been prone to errors in the past, (d) have not been reconciled on a timely basis or contain unreconciled differences, (e) contain intercompany transactions, or (f) are otherwise associated with an identified fraud risk.
• Journal entries or other adjustments processed outside the normal course of business. Nonstandard entries might not be subject to the same level of internal control. Other adjustments such as consolidating adjustments, report combinations, and reclassifications generally are not reflected in formal journal entries and might not be subject to the entity's internal controls.

It is also important that auditors carefully consider fraud risks associated with journal entries processed through automated systems, as the risk of management override of controls is not limited to journal entries processed manually.

Completeness of the Population

Auditors should test the list of journal entries for accuracy and completeness.

Auditing journal entries generally involves selecting journal entries for testing from the population of journal entries produced by the company. In accordance with AS 1105, Audit Evidence, the auditor should evaluate whether the information is sufficient and appropriate for purposes of the audit by performing procedures to:

• Test the accuracy and completeness of the information or test the controls over the accuracy and completeness of that information.
• Evaluate whether the information is sufficiently precise and detailed for the purposes of the audit.

This includes testing accuracy and completeness of the journal entry population produced by the company from which journal entries and other adjustments were identified and selected for testing, including, if applicable, those imported into software audit or data extraction tools, or other systems-based techniques.

Testing of Journal Entries

Auditors should use professional judgment in determining the nature, timing, and extent of the testing of journal entries.

The procedures for testing journal entries and other adjustments include:

• Substantive testing of specific items. Even though controls might be implemented and operating effectively, the auditor's substantive procedures for testing journal entries and other adjustments should include the identification and substantive testing of specific items.
• Examining supporting evidence for the selected journal entries (and not just relying on inquiry alone) and determining whether such evidence corroborates or contradicts the risk assessed around journal entry processing.
• Providing an appropriate rationale or basis for excluding journal entries from the auditor’s testing that met the fraud risk criteria.