Existence

Definition

In auditing, existence refers to the assertion that assets and liabilities reported in the financial statements are real and that they exist at the date of the statements. This is crucial because if assets are overstated or liabilities understated, it can significantly mislead stakeholders regarding the true financial position of an entity.

5 Must Know Facts For Your Next Test

1. Existence testing often involves confirming balances directly with third parties, like banks or other creditors, to ensure that reported amounts are accurate.
2. Common procedures to test existence include physical inspections of inventory and cash counts, as well as confirmation of receivables.
3. The risk of fraud increases when existence assertions are not adequately addressed, as management may inflate asset values or underreport liabilities.
4. Existence is particularly critical in audits of cash balances, where auditors must ensure the cash reported is not fictitious.
5. Auditors must be cautious with estimates; for example, if a company estimates receivables based on historical data, they must ensure these estimates reflect real, collectable amounts.

Review Questions

• How can an auditor effectively test the existence of cash balances in a company's financial statements?
  • To test the existence of cash balances, an auditor can perform bank confirmations where they directly contact the bank to verify account balances. Additionally, conducting surprise cash counts can help validate that the cash reported on financial statements aligns with what is physically available. These methods help mitigate risks associated with potential misstatements regarding cash assets.
• What procedures should be used to confirm the existence of investments reported on a company's balance sheet?
  • To confirm the existence of investments, auditors typically use external confirmations with custodians or brokers who hold the securities. They might also review transaction records and agreements related to these investments to ensure they are accurately reported. Physical inspection of certificates may also be performed if applicable. This ensures that the investments listed truly exist as stated.
• Evaluate how inadequate testing of existence assertions could lead to significant audit failures, particularly in relation to financial instruments and their reporting.
  • Inadequate testing of existence assertions can lead to major audit failures by allowing inflated asset values or understated liabilities to go undetected. This is particularly pertinent for financial instruments where market conditions may affect valuations dramatically. If an auditor fails to confirm that these instruments exist or are accurately valued, it could mislead investors about the company’s true financial health. Such oversights not only compromise audit integrity but can also result in legal ramifications for auditors and significant losses for stakeholders.

Related terms

Rights and Obligations: This assertion verifies that the entity holds rights to its assets and is responsible for its liabilities, ensuring proper ownership is recorded.

Completeness: Completeness asserts that all transactions and accounts that should be included in the financial statements are indeed included, preventing material misstatements.

Valuation: Valuation refers to the assertion that assets and liabilities are recorded at appropriate amounts in accordance with accounting standards.