## Audit of Operating Expenses

### Step 1 — Study and Evaluate Internal Controls

Before substantive testing, understand the control environment over expenses:

Review authorisation procedures — who can approve which categories of expense, up to what limits
Identify control gaps to calibrate the nature, extent, and timing of further audit procedures

### Step 2 — Substantive Analytical Procedures

Perform analytical procedures over the expense population:

Technique	What to do
Trend analysis	Compare current-year expenses with prior-year totals
Rate comparison	Compute an expected rate (e.g., interest rate, expense ratio) and compare with the actual figure
Reasonableness test	Assess whether expense levels are consistent with business activity

If differences are noted, inquire of management and obtain corroborating evidence.

### Step 3 — Verify Individual Expenses (Vouching)

1. Reference supporting documents — invoices, bills, contracts, board approvals

2. Check calculations — recompute accruals, allocations, or interest workings where required

### Audit of Interest / Borrowing Costs (sub-topic)

Independently compute the expected interest rate using loan agreements and outstanding balances
Compare the computed (expected) rate with the rate actually charged in the books
Inquire about differences and obtain satisfactory explanations or audit evidence

Worked example

### Example 1

Interest Audit Example:

A company has a term loan of ₹50 lakhs at 12% p.a. The auditor independently calculates expected interest = ₹6 lakhs. The books show ₹7.2 lakhs charged. The difference of ₹1.2 lakhs is inquired into — management explains a penal rate was applied for two months of delayed repayment. The auditor verifies the bank notice and agrees the charge.

### Example 2

Operating Expense Reasonableness Check:

Sales have grown 5% year-on-year but advertising expenses have grown 40%. The auditor flags this as unusual, performs analytical procedures, and requests supporting invoices and campaign approvals. The high increase is substantiated by a new product launch campaign documented in board minutes.

⚠️ Common exam mistakes

Skipping the internal control evaluation step and jumping directly to vouching — this means audit effort is misdirected and risky areas may be under-tested
Only checking that an expense is supported by a document without verifying authorisation — a voucher exists but no approval may indicate a control breakdown
Using the actual rate in the books as the benchmark instead of independently computing the expected rate from loan agreements
Not investigating differences between expected and actual figures — analytical procedures are only useful if follow-up is done on anomalies
Forgetting to recheck arithmetic/calculations on accruals, especially for interest and depreciation where computation errors are common

Reference:

Now that you've read this — what's next?

Move from understanding → mastery in 3 clicks. Each option below picks up from this lesson's topic.

🔥 Drill 5 Qs on this → ✍️ Adaptive practice →