One quick and effective method to determine whether a transaction stream requires further investigation is the reasonability test. This test requires understanding the relationship between two or more components such as a balance sheet amount and its corresponding income statement amount. In a review engagement, if the end result of the test appears reasonable a practitioner may choose to do no further analysis. There are several common items that could be tested for reasonability. They are:
| Income Statement Item | Corresponding Balance Sheet Item | Reasonability Test |
|---|---|---|
|
Interest or dividend income |
Investments |
Using average investment times average rate of return, compare to actual investment income earned. |
|
Revenues & expenses involving GST |
GST collected and paid |
Compare GST rate times percentage of applicable revenues & expenses to actual net GST remitted or claimed as an ITC. |
|
Interest expense on long term debt |
Long term debt |
Using average debt balance times average interest rate, compare to actual interest expense. |
|
Salaries & wages |
Not applicable |
Reconcile salaries & wages to T4 period and compare results. |
|
Employer’s portion of benefits expensed compared to salary expense |
Not applicable |
For each benefit type, apply applicable rate to salary expense and compare to benefit expense amount. E.g. Compare salary expense multiplied by CPP rate (adjusted for multiple calendar years if required) to CPP expensed. |
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