Auditing Construction in Progress Under Hong Kong Financial Reporting Standards: A Comprehensive Guide for Hong Kong Auditors
As an auditor in Hong Kong, you are well aware of the challenges that come with auditing complex financial statement line items like Construction in Progress (CIP). To ensure compliance with the Hong Kong Financial Reporting Standards (HKFRS) and meet the high standards set by the Accounting Financial Reporting Council (AFRC), it is crucial to have a deep understanding of the factors to consider when auditing CIP. In this blog post, we will discuss the key points to take note of when performing such audits, focusing on risk assessment, internal controls, and audit procedures. We will also introduce our powerful Audit Program 3.0, which can effectively help CPA firms reduce time costs by 99.99% as all illustrative documentation is generated and customized.
1. Assessing Assertion Level Risks, Inherent Risks, and Control Risks
The first step in auditing Construction in Progress is to assess the assertion level risks, inherent risks, and control risks associated with this financial statement line item. Applying HKSA 315 (revised) guidance on the identification and evaluation of the risks of material misstatement, auditors should consider factors such as the complexity of the construction projects, the accuracy and completeness of the CIP balances, and the potential for management override.
To justify the risk levels assigned to each type of risk, auditors should document the client’s specific risk factors and the potential impact on the CIP balance. It’s essential to stay informed about the economic and regulatory environment, as changes in these areas could significantly influence the risk assessment.
The following is a sample of illustrative documentation of the risk assessment process extracted directly from our Audit Program 3.0:
“Assertion Level risk assessments for construction in progress account balance:
Assertion 1: Existence
Management has represented that the CIP balance relates to actual construction projects that are in progress. The level of CIP appears reasonable based on the company’s level of construction activities. Therefore, existence risk is assessed as low risk.
Assertion 2: Valuation
CIP is recorded at actual cost incurred which can be objectively determined based on supplier invoices and contractor bills. There is a system in place to regularly monitor and update the value of CIP based on progress of the construction. Therefore, valuation risk is assessed as low risk.
Assertion 3: Rights
Management has represented that the company has legal title over the construction projects included in CIP and there are no disputes over ownership. Therefore, rights risk is assessed as low risk.
Conclusion
Based on the low risk assessments for all relevant assertions, the overall risk for the construction in progress account balance is assessed as low risk. No significant issues have been identified at the planning stage that would cause the risk level to be higher. However, substantive audit procedures still need to be performed to obtain sufficient audit evidence for the CIP balance.”
2. Understanding the Design and Implementation of Internal Controls
As part of the requirements set forth in HKSA 315 (revised), auditors must gain a deep understanding of the client’s internal controls surrounding Construction in Progress. This involves evaluating the design and implementation of control activities, as well as the frequency, type of control, and personnel responsible for each activity.
When documenting internal controls, it’s important to provide a clear, step-by-step description of the business process for CIP. This should include details on the initiation, authorization, and recording of transactions, as well as the periodic review and reconciliation of the CIP balance. Moreover, auditors should scrutinize the segregation of duties and consider how the client’s IT systems and applications contribute to an effective control environment.
3. Designing Audit Responses and Procedures
After identifying and assessing the risks and understanding the client’s internal controls, the next step is to design audit responses that address each assertion level risk. To achieve this, auditors must carefully consider the factors influencing Construction in Progress and develop appropriate audit procedures.
In documenting these procedures, it’s crucial to provide a comprehensive explanation of the steps involved, the documents to be checked, and any necessary confirmations or discussions with management. For example, auditors may need to test the accuracy and completeness of the CIP, verify the appropriateness of the estimates used, and assess the reasonableness of management’s assumptions and judgments related to CIP.
The following is a sample of illustrative documentation of the design of audit procedures extracted directly from our Audit Program 3.0:
“Assertion 1: Existence
Audit Procedure 1.1: Obtain a detailed listing of Construction in Progress projects from the client’s accounting records and verify the existence of a sample of projects by inspecting relevant documentation, such as contracts, project plans, progress reports, and invoices.
Audit Procedure 1.2: Perform site visits to a sample of ongoing construction projects to confirm the physical progress and compare it with the client’s accounting records.
Audit Procedure 1.3: Review and assess the client’s capitalization policy for Construction in Progress to ensure consistency with the applicable financial reporting framework and industry practice.
Assertion 2: Completeness
Audit Procedure 2.1: Perform a roll-forward of the Construction in Progress opening balances to the current year-end balances, ensuring that all transactions have been properly recorded.
Audit Procedure 2.2: Reconcile the client’s Construction in Progress listing to the general ledger and investigate any reconciling items.
Audit Procedure 2.3: Review the client’s process for identifying and recording construction project transactions to assess the risk of unrecorded or improperly recorded transactions.
Assertion 3: Valuation
Audit Procedure 3.1: Assess the client’s method for allocating costs to Construction in Progress projects, including direct and indirect costs, for consistency with the applicable financial reporting framework, industry practice, and the client’s past practices.
Audit Procedure 3.2: Test a sample of costs allocated to Construction in Progress projects by vouching the costs to supporting documentation, such as invoices, contracts, and payroll records.
Audit Procedure 3.3: Review the client’s process for identifying and recording changes in project estimates, including cost overruns, and assess the impact of such changes on the valuation of Construction in Progress.
Assertion 4: Accuracy
Audit Procedure 4.1: Verify the mathematical accuracy of the Construction in Progress schedule, including the total costs, accumulated costs, and percentage of completion calculations.
Audit Procedure 4.2: Test a sample of Construction in Progress transactions for proper recording in the general ledger, including the appropriate account classification and amounts recognized.
Audit Procedure 4.3: Confirm that the client’s accounting for Construction in Progress is in accordance with the applicable financial reporting framework, including proper presentation and disclosure.
Conclusion
The designed audit procedures are in response to the low-risk level on the assertions identified for the Construction in Progress account balance. By performing these procedures, we aim to obtain sufficient appropriate audit evidence to conclude that the risk of material misstatement in the account balance is low.”
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Navigating the complexities of auditing Construction in Progress under HKFRS can be challenging. However, with our innovative Audit Program 3.0, CPA firms can significantly reduce time costs by 99.99%. Our automated program generates customized, illustrative audit programs, risk assessments, and documentation of internal controls relevant to any client industry and principal activity. By streamlining the audit process, Audit Program 3.0 allows auditors to focus on ensuring the highest level of audit quality and compliance.
In conclusion, auditing Construction in Progress under HKFRS requires a thorough understanding of risks, internal controls, and audit procedures. By following the guidelines set out in this blog post, auditors can navigate the intricacies of this financial statement line item and uphold the rigorous standards set by the AFRC. Moreover, with the unparalleled efficiency of Audit Program 3.0, CPA firms can confidently tackle even the most challenging audits and deliver exceptional results.