Introduction to Reasonableness Test

Reasonableness test is an audit procedure that the auditors would use to examine the reasonableness of accounting events or transactions that a company has recorded in its financial statements. The auditors can achieve this by using information or data from at least two different sources to forecast accounting events or transactions.

Also, this test is an analytical procedure that people will commonly use when they want to test the kinds of expenditures that always occur.

The primary principle of the procedure is to use a transaction or an event to forecast or analyse the reasonableness of other relevant deals. For instance, there is a close relationship between the cost of goods sold and the inventories and sales revenues.

The auditors may utilise information from the cost of goods sold and the inventories (Also see FRS 2 Inventories) to examine the reasonableness of the sum of profits that a firm has recorded in its financial statements. They may also perform the test on the utility expenses or the depreciation expenses.

In this article, we will see how, when, and why the auditors from the audit firms in Johor Bahru are implementing the reasonableness test.

Example

As an instance, you need to perform audit procedures in the cycle of the fixed assets. Before you start implementing the substantive testing on the fixed asset which a firm has reported in its financial statements, you need to have an in-depth understanding in the key controls associated to the fixed assets of the firm. The control includes the management’s authority on the rate of depreciation (Also see Difference between Depreciation and Impairment), fixed asset control, as well as the purchase of fixed assets.

It is of utmost importance for you to understand the key internal control  (Also see Test of Control) associated with the cycle that you have to test so that you may achieve a successful reasonableness test. If you do not have a thorough understanding, you may misinterpret your testing result.

So, let us assume that you have decided to conduct a test on the controls, and those controls consist of depreciation and the purchasing authorities. Another assumption is that the firm has implemented the correct way to present the depreciation charge in its financial statements, and there is no issue about the control of depreciation. Thus, you may start the reasonableness test now.

You know that the firm has charged the depreciation expenses of the fixed assets correctly. As soon as you have found out what the ways are, for instance, the firm is calculating the depreciation by using the straight-line method; you should calculate the depreciation expenses independently and forecast the sum of the expenses for that year.

However, you need to predict the threshold on the amount of difference you would accept, as well as how much is the amount that you would inspect before you compare the real expenses in your customer’s financial statements and the predicted expenses.

Keep in mind that the reasonableness test will help the auditors to determine whether the amounts and balances of the transactions and events that their customer has recorded in the financial statements are reasonable. Nonetheless, the auditors should still perform other testing such as vouching, inspection as well as observation when necessary.