Audit Retained Earnings and Dividends
As auditors, we usually examine all relevant transactions in the audit of retained earnings and dividends. This is due to there are usually only a few transactions of retained earnings and dividends, but the amount of these transactions is usually material.
The audit work regarding the retained earnings and dividends is usually about the review and analysis of the changes in retained earnings. Likewise, the changes usually come from the two types of transactions, such as net income transferred from profit and loss statement and the dividend. That is why dividend is included in the audit of retained earnings here.
For net income, it is the net result of all revenues deducting all expenses during the year. And the revenue and expense transactions usually have already been examined by the time we start auditing retained earnings.
Of course, other transactions such as prior-period adjustment may also affect the changes in retained earnings. And sometimes, there are restrictions on retained earnings that bar the company from paying out the dividend to its shareholders. Hence, we may need to pay more attention to these issues if any of them occur.
Audit assertions for retained earnings and dividends
Like many other financial statement line items, we usually need to test various audit assertions in the audit of retained earnings and dividends. Likewise, these audit assertions for retained earnings and dividend are included in the table below:
|Audit assertions for retained earnings and dividends|
|Completeness||All retained earnings related transactions (e.g. dividends declared and prior-year adjustment) that should have been recorded have actually been recorded.|
|Existence||Dividends recorded in the financial statements, resulting in the deduction of retained earnings, have been properly approved and declared.|
|Presentation and disclosure||Sufficient and appropriate disclosures (e.g. any restrictions on retained earnings, dividend preference, dividend rate, dividends in arrears, etc.) have been made in the notes to financial statements.|
Audit procedures for retained earnings and dividends
Completeness, existence, and presentation and disclosure are the three audit assertions that we usually have concerns on when we perform the audit of retained earnings and dividends. Likewise, we need to examine these three assertions in the audit procedures for retained earnings and dividends.
We test completeness assertion for retained earnings and dividends to verify whether all related transactions that occurred during the year, such as declared dividends and prior-period errors correction, are properly recorded in the client’s accounts.
Example: test of completeness assertion in the audit of retained earnings and dividends include:
- Request board minutes from the client and make inspection for the evidence of declaration of dividend
- Trace evidence of dividend declaration in board minutes to the general ledger
- Trace prior-period errors correction or adjustment with supporting documents to retained earnings account
- Verify if the declared dividends should have been recorded in the current period
The declared dividends that should have been recorded in the current period but are recorded in the next period is the issue of completeness.
In the audit of retained earnings and dividends, we test the existence assertion to examine whether there are dividends that are recorded and/or paid without evidence of declaration from the client’s board of directors. Additionally, dividends that are not properly approved before being declared should not be recognized in the accounting records either.
Example: test of existence assertion for retained earnings and dividends include:
- Select all dividend transactions, such as declared and/or paid dividends, that occurs during the year
- Vouch all those dividend transactions to board minutes for the evidence of approval and declaration
- Verify if the declared dividends have been recorded in the correct accounting period
The declared dividends that should have been recorded in the next period but are recorded in the current period instead is the issue of existence.
Presentation and disclosure
The main concern regarding presentation and disclosure for retained earnings account is that there may be some restrictions that are placed on the retained earnings by the client’s banks, bondholders, or other creditors. Such restrictions usually limit the client’s ability to make payments of dividends to its shareholders.
In this case, we need to carefully examine the agreements that the client has with those parties. If any restrictions exist, we need to make sure that the client has properly disclosed them in the notes to financial statements.
Other disclosures that are usually required may include dividend rate, dividend preference, dividends in arrears, and any adjustment made to prior-period, etc.