 in this presentation we will discuss the audit process related to prepaid expenses we'll start off with discussing what prepaid expenses are prepaid expenses are a type of other assets which lead to the question of course of what are other assets first a word from our sponsor well actually these are just items that we picked from the youtube shopping affiliate program but that's actually good for you because these aren't things that were just given to us from some large corporation which we don't even use in exchange for us selling them to you these are things that we actually researched purchase and use ourselves here we have a western digital wd elements 20 terabyte usb 3.0 desktop external hard drive we use as part of our backup system noting that if you lower the number of terabytes of storage the price will lower dramatically as well when you're thinking about a backup system you're usually thinking about an online system or an external hard drive system like this or ideally some 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accounting instruction.thinkific.com where we have many different courses you can purchase one at a time or have a subscription model given you access to all the courses courses which are well organized have other resources like excel files and pdf files to download and no commercials other assets or assets to provide economic benefit under a year when we consider prepaid expenses what we're thinking about are those types of things where typically we have made a payment before we have received the benefit the most common type of prepaid expense that we learned in financial accounting and would be audited for within audit is prepaid insurance so insurance is the classic example because of course whenever we pay for insurance the definition of insurance means that we're buying the insurance for something that's going to be insured in the future therefore we haven't received anything at the point in time that we paid for the insurance we're going to be receiving the benefit the coverage the coverage against risk in the future and typically when we're talking about large companies they'll be buying insurance that might be at least a year into the future why because it's typically cheaper in order to do that rather than paint on a month to month type basis we need to consider in that case the prepaid insurance but of course we can't have prepaid types of any types of items where we pay for the item before we actually receive the item a little bit unusual remember because typically you would think that we would pay for the item at the point in time we'd receive it whether it be goods or services or possibly after in this case we're paying before we receive the goods or services typically being prepaid insurance but we could prepay things like rent rents another item that we could have circumstances in which prepaying the rent would be a smart thing to do if that was the case then we would treat the prepayment and the audit of it in a similar fashion as we would for prepaid insurance we could have prepaid interest as well and similar kind of fashion there anything that we of course decide that we're going to pay before we get the goods or services typically we try not to do that because most of the time the company will want to pay after because it's the time value of money if at all possible delay the payment as much as possible the place where we cannot do that typically is prepaid insurance and there might be negotiation or or agreement type formats which would lead as to want to be in a situation where we would prepay the rent or some other type of expense and so the inherent risk related to prepaid expense recalling that inherent risk is the risk that just basically inherent to the process we're looking at so if we were to remove the internal controls what would the inherent risk recall that inherent risk we want to consider inherent risk we want to consider control risk the two things that we as the auditor don't really have control over those are in control by the company inherent risk by the choice of business they are in control risk by the controls they put in to deal with that inherent risk we then set detection risk which is going to be the level of audit or substantive testing we will think about so we want to think about inherent risk control risk set detection risk so generally determined to be low the inherent risk the accounts do not generally involve complex continuous accounting issues so because prepaid insurance is pretty straightforward given the other types of things that can go on we do have to consider the calculation of prepaid insurance but oftentimes it's going to be something that may not be the most material of factors in terms of dollar amounts and it's not that complex to really figure out the prepaid insurance we get the policy and we could figure out how much has expired and how much has not expired it's not not too difficult other than knowing the components that will be involved that typically be in the insurance policy and then the payments considering those two items to figure out the amount that has expired and that has not expired the control risk so now we could consider the control risk the controls that the organization has to put in place once we consider control risk and inherent risk we could set detection risk to see the level of testing we want to do procedures related to the purchasing process should ensure that each item is properly authorized and recorded because prepaid insurance are usually processed through the purchasing process so when we consider in other words prepaid expenses we are going through a purchase process within the prepayment process and therefore when we audit the prepayment cycle we should be auditing the prepaid expenses as well the same kind of controls that are going to be in place so this is another area of course as we construct the audit process there will be overlap when we consider these different types of accounts we need to consider where that overlap will be so that we could do the enough testing that we need but a minimal amount of testing in order to make the audit process efficient then we have the substantive procedures we're going to say related to prepaid insurance in this case so we have the substantive procedures we have the inherent risk the detection risk then we have the inherent risk and the control risk then setting the detection risk and then considering the substantive procedures the actual testing items that we would be doing within the audit test of details of prepaid insurance accounts step one is to get a schedule of the prepaid assurance account so obviously we're going to need a schedule we're going to not want to know when the payments we're going to be made we're probably also going to need the policy so those are the two things we're typically going to need if we see if we get the GL account or the trial balance if we get the trial balance we're going to look at prepaid we're going to say we need the GL account now most of the time the company will be posting their payments to the GL account of prepaid insurance and then they should be if they're a publicly traded company doing the month end reconciliation and then we should just have to basically review that so if you have questions about that you want to go to financial accounting think about the year end adjusting entry if you're talking about publicly traded companies they should have completed the adjusting entry which means they would be posting their items when they make the payment to insurance to prepaid expenses an asset not a liability then at the end of a time period typically a month they would make the adjustment to adjust the amount that has expired and the amount that has not been expired the amount that remains in prepaid expense the amount that is not now if you're auditing a very small company or doing a review or a compilation or something like that quite possible that they didn't do the the period in adjustment and you may actually have to look at that period in adjustment which is basically just an adjusting entry or it could be possible that instead of posting the transactions to prepaid insurance they're posting it to a prepaid to insurance expense and in that case of course you would just basically do the reverse of the adjusting entry instead of adjusting it out of prepaid insurance you would be saying okay now prepaid expenses overstated you'd have to reduce that again publicly traded company that adjusting entry you would think had been taken place and we just need to basically test to see if it was done properly assertions related to prepaid insurance includes valuation calculate portion of the policy that is not expired and portion that is so with regard to valuation we're going to get the policy we're going to say okay how much time period does this policy cover and and then we're going to consider how much of the policy has expired and how much of the policy has not been expired so the assumption here we have the policy policy has been paid for we could see that the policy has been paid for then we consider the policy that has been paid for how much of it has expired how much is of it has not expired the amount that has not expired then should be still reported as prepaid insurance, the amount that has expired should be expense. Rights and obligations, confirm policy beneficiary, so we want to make sure that we know who the beneficiary is of the policy, inquire the insurance broker, so it's useful to be able to talk to the insurance broker because the insurance broker is outside of the organization, so it gives us a little bit more confirmation or assurance, a little bit better evidence that we can compile to give us assurance about prepaid insurance, existence and completeness, so with the assertion of existence and completeness, confirm policy with the insurance broker, so again we could talk to the insurance broker about that outside of the company, bit more assurance, examine supporting source documents, so we can consider the source documents as well, and then we have classification, so classification assertion determine the correctness of classifications to accounts, we want to make sure that the accounts are being properly classified or the amounts are being properly classified to the proper classes.