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The purpose of audit tests, or audit procedures, is to allow the auditor to collect sufficient appropriate audit evidence to be able to conclude with reasonable assurance that the financial statements (FS) are free of material misstatement. If sufficient appropriate audit evidence cannot be obtained, or the evidence points to a material misstatement in the FS, the auditor will have to issue a modified audit opinion. Misstatements will find their way into published financial statements only if three events all happen:
There are therefore two lines of defence preventing an error that has occurred from ending up in the published FS: the internal control system and the work auditor carries out. If the client’s internal control system is good, there is a reduced likelihood that there will be an error in the FS and the auditor will reduce the amount of audit work to be carried out. If the internal control system is poor, the auditor will have to perform much more work as the audit is the only defence left against a material misstatement appearing in the published FS. Therefore, the auditor must:
Consider the receivables amount in the SOFP. One way in which this could be misstated would be if it were incorrectly valued, perhaps because a large balance was owed by a customer who was unlikely to pay. The controls that would help to prevent that include:
The operation of these controls needs to be tested. For example:
Each of these audit tests are testing a control or control procedure. They are therefore tests of control. These tests are not investigating the receivables balance in the SOFP. I repeat, a test of control tests controls, not amounts in the FS. Tests of control can be grouped into:Enquiry and confirmation. For example, ask the credit controller about the way in which customers are encouraged to pay and ask how these customers are identified and how often they are followed up. This is a relatively weak source of evidence because the credit controller might exaggerate his or her efforts. Inspection. For example, the credit references or notes made by the credit controller of conversations. Observation. For example, observing the credit controller at work. Recalculation and reperformance. For example, ensuring that the aged receivables analysis seems to be accurate. Even when internal control systems are very good, the auditor will always carry out tests on the figures in the FS. The work has to address all the assertions made by each material figure. For example, valuation, completeness, existence etc. These tests are substantive tests and consist of:
So, staying with receivables, the auditor would calculate the receivables collection period. If this were not too large and broadly in line with previous periods, the auditor would have gained some evidence about valuation (ie most debts not very old). Tests of detail would include:
Substantive tests therefore include analytical procedures in addition to the four classes of audit procedures available for testing controls, so giving the well-known mnemonic AEIOU: Analytical procedures Enquiry and confirmation Inspection Observation RecalcUlation and reperformance Remember if the tests of control show that controls are not operating correctly, the auditor will have to increase the substantive tests. For example, if the client does little to assess customers’ credit worthiness to ensure, as far as possible, that debts are recoverable, the auditor will have to do much more work on the receivables figure in the SOFP to be satisfied that the amount is valued at a true and fair amount. What are the differences between tests of controls and substantive tests of transactions?Substantive testing is very different from testing controls. Substantive tests verify whether information is correct, whereas control tests determine whether the information is managed under a system that promotes correctness. Some level of substantive testing is required regardless of the results of control testing.
What is a substantive test of transactions?Substantive testing is known as the phase of an audit where the auditor gathers samples to identify any material misstatements in the client's accounting records or other information. This proof is required to support the judgment that a company's financial records are complete, relevant, and accurate.
What are the two types of substantive tests?There are two categories of substantive procedures - analytical procedures and tests of detail. Analytical procedures generally provide less reliable evidence than the tests of detail.
What is the difference between substantive and compliance test?Substantive testing is always performed after compliance testing. In cases where compliance testing indicates weaker controls, then substantive testing can be more rigorous. On the other hand, if the results of compliance testing indicate stronger internal control, then the substantive testing can be even waived off.
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