Management Assertions: Account Balances
This category of management assertions addresses the correctness of balance sheet account balances at year-end. These account balances include the company's assets, liabilities, and equity. Here's a refresher on the balance sheet accounts:
Assets are resources the company owns; for example, cash, accounts receivable, and property, plant, and equipment (PP&E).
Liabilities are claims against the company by other businesses. Examples of liabilities are accounts payable, unearned revenues (which occur when a client pays the business for goods or services it hasn't yet received — like a deposit), and salaries payable (wages the company owes to employees).
Equity (also known as net assets or net worth) represents the difference between assets and liabilities. Examples of equity are retained earnings (the total of all company earnings from day one to the date of the balance sheet after deducting dividends) and common stock.
Four types of management assertions directly influence account balances:
Existence: This means that any asset, liability, or equity account and dollar balance on the financial statements actually exists as of the balance sheet date. For example, assuming a December 31 year-end date, if the company purchases a delivery truck in October, the asset account must reflect the cost of that truck plus any other trucks it owns.
Rights and obligations: The balances reflect assets the company owns or obligations the company owes. A car that the business's president owns isn't shown on the balance sheet in the vehicle asset account. It doesn't make any difference if the president drives the car only for company business; he (not the company) holds legal title to the car.
Completeness: All balances as of the balance sheet date are complete and include all transactions that occurred during the year. For example, if the company sells a delivery truck, the truck and all related depreciation are removed from the balance sheet, and the gain or loss on the sale is recorded in equity. Depreciation is the way the cost of using assets is moved from the balance sheet to the income statement.
Valuation and allocation: Valuation means that a business records all account balances in the right amounts, and allocation means that the company records the amounts in the appropriate accounting period.
For example, a company takes a physical count of its inventory, which totals $500,000. The inventory asset account on the balance sheet shows $510,000. The difference (shrink) between the two ($10,000) needs to be allocated from inventory to the current year expense cost of goods sold.