What Are the Assertions Related to Equity?

What Are the Assertions Related to Equity?
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Accounting Standard No. 15 Auditing Evidence governs assertions during an audit that are related to a firm's equity. A firm's management and shareholders are subject to specific assertions related to equity at the cut-off end of an accounting period. These include disclosures of its existence and the rights and obligations of each entity involved as well as the maintenance of accurate, complete balance sheet records.

A financial statement assertion is effectively a claim by a company that its financial statements and financial reporting are accurate and honest and that income statements and other financial statements were prepared according to required standards, laws and regulations.

The American Institute of Certified Public Accountants (AICPA) allows auditors to gather this financial information as audit evidence. There are four categories of account balance assertions: existence, rights and obligations, completeness and valuation.

Existence Assertion

An existence assertion literally means that the cited assets, liabilities and equity balances exist at the end of a cited period of time. A firm records the equity interest of each of its investors on its balance sheet. These records are filed with the U.S. Securities and Exchange Commission by publicly traded companies.

An auditor can gauge the records a public or private firm keeps of its assets and liabilities as a means of gathering evidence in addition to the firm's equity interests. This ensures that complete records of a firm's financial position exist. A firm must disclose all of its shareholder equity to an auditor.

Rights and Obligations Assertions

Management assertions and obligations assertions confirm that the company does indeed own the assets in question or at least owns the right to benefit from them, explains the Corporate Finance Institute. An entity is entitled to the equity it purchased from the firm and is obliged to cover all liabilities it undertook, according to the AICPA, whether the entity is an individual or a group investor.

The company's management is responsible for asserting this information to the auditor in compliance with generally accepted accounting principles, or GAAP. Management must also disclose all classes of transactions that are pertinent to an entity's equity, including evidence to support that each entity involved met its obligations.

Completeness Assertion

As the term implies, a completeness assertion effectively means that the company's financial statements are complete. All liabilities, assets and equity balances appear there. In addition to recording and disclosing all of a firm's equity interests, each disclosure made to an auditor must be factually complete and accurate. All assets, liabilities and equity interests must be recorded on the firm's balance sheet.

An auditor should pay close attention to the completeness of all records pertaining to cash transactions because employees can often overlook or fail to report cash receipts.

Valuation and Allocation Assertions

The AICPA requires a firm's equity interests to be accurately recorded in its financial statements. Company managers must also record any equity valuations and allocations. The volume of shares issued must be recorded if a firm issues additional shares of common stock. The price at which the company issued the shares must also be recorded.

The percentage of shareholder equity changes if a firm issues additional stock or recalls additional stock. Such a change must also be reflected in the firm's financial statements. This assertion also supports the accuracy of all valuations.

Auditing Standard No. 15

An audit can be a risk assessment procedure, a test of internal controls, or a substantive procedure, according to the Public Company Accounting Oversight Board. In addition to governing audit assertions, it also clarifies and defines auditing procedures in paragraphs 15 through 21. Acceptable methods include inquiry and analytical procedures, giving rise to the assertions being made.