BAA6003 2 Substantive and Compliance Testing Refresher

BAA6003
Substantive and Compliance Testing -

Refresher
Objectives
1. To outline the contribution substantive testing and the tests of controls make to an audit
2. To present the different forms that substantive and compliance testing can take
Why use substantive testing?
• Auditors need to obtain sufficient, appropriate audit evidence to support the financial statements,
• Substantive procedures can be used to obtain that evidence

Objectives of substantive procedures
The overall objective of substantive testing is to verify the validity, completeness and accuracy of the
financial statements and note disclosures and:
• That account balances are valid
• That account balances are complete
• That account balances represent items owned by the entity
• That account balances are arithmetically correct
• That account balances are properly valued
• That account balances are correctly classified
• That items have been included in the correct accounting period
• That account balances are properly disclosed
Examples of how audit objectives are achieved
Audit objective Typical audit tests
Completeness review of items after the period end
cut off
analytical review
confirmations
reconciliations to control account
sequence checks
Rights and checking invoices for proof that item belongs to the company
obligations confirmation with third parties
Valuation checking to invoices
recalculation
confirming accounting policy consistent and reasonable
review of post period end payments and invoices
Existence physical verification
third party confirmations
cut off testing
Occurrence inspection of supporting documentation
confirmation from directors that transactions relate to business
inspection of items purchased
Measurement recalculation of correct amounts
third party confirmation
expert valuation
analytical review
Disclosure check compliance with law and accounting standards
true and fair override invoked
What is substantive testing?
Substantive procedures are audit procedures designed to detect material misstatements at the assertive
level.
They consist of
• 1. Analytical procedures
• 2. Tests of details (of classes of transactions, account balances and disclosures)
Analytical Review
Analytical procedures include the consideration of comparisons with:

• Comparable information for prior years (eg last year’s revenue with this year’s)
• Anticipated results from budgets or forecasts
• Expectations prepared by the auditor (depreciation estimates)
• Industry information (what are the usual net profit margins in different industries)
Use of analytical review
Specific analytical procedures as preliminary tests
• to test the reasonableness of the account balances as a basis for deciding the extent to which further
substantive testing is required.
Specific analytical procedures as complete tests
• to test the reasonableness of the balance where less substantive testing is required
The use of analytical procedures at the substantive testing stage is optional, but auditors must perform
analytical procedures at the planning and finalisation stages of the audit.
Tests of detail
Substantive test of details may involve testing the transactions which give rise to an account balance or
directly testing the balance itself. The approach adopted is generally that which provides the most efficient
means of testing the validity, completeness and accuracy of the account balance in question.
Testing transactions
Where the number of transactions affecting the account during the reporting period is small relative to the
size of the account balance, testing the transactions affecting the account may be more efficient than directly
testing the closing balance.
Direct tests of balances

For some accounts it is more efficient to audit the closing balance directly rather than examine the
transactions. This applies to accounts such as trade receivables, inventory etc.
Directional testing
• Tests to discover errors (resulting on over/under statement) – such testing begins with the accounting
records and tested using the supporting documents.
• Tests to discover omissions (resulting in understatement) – these tests start outside the accounting record and
then traced back to the accounting records.
Reliability of data
Reliability factors Example
Source of information Information may be more reliable when obtained from

independent sources outside the entity
Comparability of Broad industry data may need to be supplemented by the

information available specific product information of the entity
Nature and relevance of Whether company budgets are realistic or goals

the information available
Controls over the Controls over the preparation, review and maintenance of
preparation of the budgets
information to ensure its
completeness, accuracy
and validity
How to begin substantive testing?
• Agree opening balances with previous year’s working papers

• Review general ledge for unusual records
• Agree client schedule to/from accounting records to ensure completeness
• Carry out analytical review
• Test transactions in detail
• Test balances in detail
• Review presentation and disclosure in accounts
Tests of controls (compliance testing)
Reliance on accounting and internal control system
• Enhances the efficiency of the external audit. If inherent risks are mitigated by effective internal control
procedures less substantive testing is required to gather sufficient audit evidence.
• The auditor is able to add value to the client by assessing the quality of the internal control system and
giving recommendations for further improvements.
Characteristics of a good internal control system
1. Competent, reliable personnel who possess integrity
2. Clearly defined areas of authority
3. Proper authorisation procedures
4. Adequate documentation and records
5. Segregation of incompatible duties
6. Independent checks on performance
7. Physical safeguarding of assets and records

Reviewing, evaluating and gathering information
on the accounting system and its internal controls
Review
• enquiries of client personnel
• inspection of client documents
• observation of client personnel
Evaluate
• gather information about the relevant internal control procedures
• evaluate their effectiveness in preventing and detecting errors
Gather
• narrative notes
• flowcharts
• questionnaires (ICQ)
• checklists
Internal controls and testing
• Identified internal control procedures which appear to be effective

• Rely on any of these procedures to reduce substantive testing.
• This decision affects the nature, timing and extent of audit tests.
• More extensive testing performed on controls being relied upon.
• Interim audit important for control testing
• Aids audit completion

BAA6003 2 Substantive and Compliance Testing Refresher

Uploaded by

Copyright:

Available Formats

BAA6003 2 Substantive and Compliance Testing Refresher

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

BAA6003 2 Substantive and Compliance Testing Refresher

Uploaded by

Copyright:

Available Formats

BAA6003

Substantive and Compliance Testing -

• Substantive procedures can be used to obtain that evidence

Analytical procedures include the consideration of comparisons with:

Direct tests of balances

Source of information Information may be more reliable when obtained from

Comparability of Broad industry data may need to be supplemented by the

Nature and relevance of Whether company budgets are realistic or goals

• Agree opening balances with previous year’s working papers

Reliance on accounting and internal control system

1. Competent, reliable personnel who possess integrity

2. Clearly defined areas of authority

3. Proper authorisation procedures

4. Adequate documentation and records

5. Segregation of incompatible duties

6. Independent checks on performance

7. Physical safeguarding of assets and records

• Identified internal control procedures which appear to be effective

You might also like