Auditing Contract Assets Under Hong Kong Financial Reporting Standards: A Comprehensive Guide for Hong Kong Auditors
The audit of contract assets is a critical aspect of financial statement audits, particularly for companies operating under the Hong Kong Financial Reporting Standards (HKFRS). As a Hong Kong auditor, it is vital to ensure that contract assets are accurately presented and valued in compliance with the standards set by the Accounting Financial Reporting Council (AFRC). In this blog post, we will explore key considerations when auditing contract assets under HKFRS, focusing on risk assessment, internal controls, and audit procedures. Furthermore, we will introduce our revolutionary Audit Program 3.0, which can significantly reduce time costs by 99.99% for CPA firms.
1. Assessing Assertion Level Risks, Inherent Risks, and Control Risks
The first step in auditing contract assets is to assess the assertion level risks, inherent risks, and control risks associated with this financial statement line item. HKSA 315 (revised) provides guidance on the identification and evaluation of the risks of material misstatement. Auditors need to consider factors such as the complexity of the client’s contracts, the accuracy and completeness of the contract assets, 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 contract assets 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 assessment for Contract Assets
Assertion 1: Existence
The contract asset balances exist at the reporting date. Contract assets represent the company’s right to consideration for goods or services transferred to customers when that right is conditional on something other than the passage of time. Historical analysis indicates stable contract asset balances over time. The risk for the existence assertion is assessed as low risk.
Assertion 2: Valuation
Contract assets are recorded at the transaction price allocated to the unsatisfied performance obligations, adjusted for any impairment losses. The company performs periodic impairment assessments to determine recoverability of contract assets. The risk for the valuation assertion is assessed as low risk.
Assertion 3: Rights
The company has legal rights to the contract assets recorded. Contract assets only arise when the company has fulfilled contractual obligations but is yet to be paid by the customer. No indicators exist suggesting the company does not have legal rights to contract assets. Historical analysis has not revealed any challenges to the company’s rights over contract assets. The risk for the rights assertion is assessed as low risk.
In summary, the overall risk for contract assets is assessed as low risk. The company performs periodic impairment assessments to determine the recoverability of contract assets. There are no indicators that the company lacks legal rights to contract assets recorded. The risk assessment has been documented in compliance with relevant auditing standards and is sufficiently justified to allow another auditor to reach the same conclusion. The overall risk level for this account balance is low risk.”
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 contract assets. 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 contract assets. This should include details on the initiation, authorization, and recording of transactions, as well as the periodic review and reconciliation of the contract assets 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 contract assets 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 contract assets, verify the appropriateness of the estimates used, and assess the reasonableness of management’s assumptions and judgments related to contract assets.
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 listing of contract assets at the reporting date and select a sample of contract assets for testing. Verify the existence of the underlying contracts by inspecting signed contract agreements or other relevant documentation.
Audit Procedure 1.2: For the selected sample, review the client’s revenue recognition policy and ensure that the criteria for recognizing contract assets under the Hong Kong Financial Reporting Standards have been met.
Audit Procedure 1.3: Review the client’s project status reports or other progress documentation to confirm the performance obligations have been satisfied but not billed, supporting the existence of contract assets.
Assertion 2: Rights and Obligations
Audit Procedure 2.1: Inspect the terms and conditions of the selected sample of contracts to ensure that the client has enforceable rights to the contract assets.
Audit Procedure 2.2: Review the client’s process for identifying and recording contract assets, and assess the appropriateness of the recognition criteria applied.
Assertion 3: Completeness
Audit Procedure 3.1: Obtain a complete listing of contracts at the reporting date and perform a reconciliation to the contract assets recorded in the general ledger. Investigate any discrepancies identified.
Audit Procedure 3.2: Test the client’s controls over the identification and recording of contract assets to ensure that all contract assets are properly recognized and recorded.
Audit Procedure 3.3: Review subsequent billings or cash collections related to the contract assets to ensure that all contract assets have been properly recognized and recorded.
Assertion 4: Valuation and Accuracy
Audit Procedure 4.1: For the selected sample of contract assets, verify the accuracy of the amounts recorded by recalculating the revenue recognized based on the terms of the contracts and the client’s revenue recognition policy.
Audit Procedure 4.2: Assess the reasonableness of any estimates used in determining the amount of contract assets, such as the percentage of completion or the costs to complete the project.
Audit Procedure 4.3: Review the client’s process for monitoring and adjusting the contract assets for any changes in the project scope, contract terms, or other factors that may affect the valuation of contract assets.
Conclusion:
The audit procedures designed above are in response to the Low Risk level identified for all relevant assertions related to the contract assets account balance. By performing these procedures, we can conclude that the overall risk level for the contract assets account balance is Low Risk.”
Revolutionizing the Audit Process with Audit Program 3.0
Navigating the complexities of auditing contract assets 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.