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GTHW 2010 Chapter 12 Tests of Details
GTHW 2010 Chapter 12 Tests of Details
GTHW 2010 Chapter 12 Tests of Details
Summary
Introduction
12.01 Tests of details are substantive audit procedures designed to identify the
correctness of the related account balances. While tests of details can
provide evidence to both balance sheet and income statement amounts,
most tests of details focus on determining whether the ending balance
sheet is materially correct.
12.02 Voyager suggests substantive procedures based on the audit team’s risk
assessments, including the determination of reasonably possible risks and
the intended control reliance. The procedures suggested ordinarily include
tests of details in addition to substantive analytical procedures. The
decision whether to use tests of details and which tests to apply may
include considerations such as:
the risk of material misstatement
whether the tests would likely provide the needed evidence for the
pertinent risks
the costs and benefits of using tests of details versus applying other
procedures, such as analytical procedures
the costs and benefits of performing tests of controls to achieve the
intended control reliance
Since the selection of procedures must be based on the facts and
circumstances of the specific engagement, the audit team should tailor the
procedures suggested by Voyager to the engagement.
12.04 For a particular account balance, the audit team might use more than one
of these testing methods. For example, the audit team could decide to test
high value items and identify risk areas within the remaining population for
further testing.
Sampling
12.06 Sampling procedures are used to test details by applying the audit
procedures to the individual items selected. Because the items examined
in a sample are representative of the total population, the audit team is
able to project the sample results to the total population. This is not the
case with other tests of details, where the audit team selects items
according to specific criteria that may not be representative of the whole
population. Thus, the results cannot be projected to the total population,
although the audit team does form a conclusion about the examined
items.
12.08 100% examination undoubtedly provides the strongest audit evidence for
risks associated with assertions such as valuation, existence and rights
and obligations, but is not feasible or cost effective in most audit
situations. Therefore, other methods of testing details, such as sampling
or those discussed below are usually applied.
12.09 In certain situations, the audit team may test high value items (other than
in connection with sampling). In Horizon, “individually significant” is the
term used to describe high value items.
12.10 When testing a population that includes individually significant items, the
audit team is separating the population into two populations: one
comprised of individually significant items and the other comprised of
items less than individually significant. Detailed audit procedures will be
performed on 100% of the population of individually significant items. The
population of items less than individually significant must also be
considered for testing. The nature and extent of testing should respond to
the risks present.
12.12 The appropriate response is always a matter of judgment but the audit
team can only conclude on the population tested. Therefore, if the
appropriate response is to perform no audit procedures on the items in the
population that are less than individually significant, the audit team can
only conclude on the population of individually significant items.
12.13 When the population to be tested is available in electronic form, the use of
IDEA is recommended to identify the individually significant items to be
tested.
12.15 For example, suppose for a population totaling $500,000, there are two
individually significant items (defined as those over $100,000) totaling
$250,000. If there were three additional items over $50,000 totaling
$200,000, it would clearly be efficient to test all five. If the value of the
remaining items is less than tolerable error and presents no significant
risks, the audit team may decide to base audit conclusions on testing 90%
of a population's value.
12.18 The objective of any audit strategy is to obtain reasonable assurance that
material misstatements, if present, will be detected. Defining individually
significant as an amount greater than tolerable error means that there may
be items in the population greater than materiality that are not selected for
detailed substantive testing. Therefore, the audit team must determine that
this strategy appropriately responds to the risks in the population and
satisfies the objective of obtaining reasonable assurance.
12.19 The risks in a given population will vary from client to client and industry to
industry. For example, a bank establishes internal controls around the
existence assertion of commercial loans to enforce management’s policies
and objectives. Typically, these controls operate on all loans regardless of
size. Therefore, testing the operating effectiveness of the controls
provides the audit team with a basis to use an individually significant
amount that exceeds tolerable error. If a bank did not have such controls
that operate on every transaction or they did not operate effectively, the
audit team would not use the audit strategy described above because they
cannot obtain reasonable assurance that all loans exist.
12.21 It is vital that the population be comprised of related items with similar
characteristics. Items are related when they share common attributes or
characteristics such as the type of loan. If, for example, a population of all
loans in a bank were used, two undesirable outcomes would transpire.
First, it would be unlikely that consumer, credit card, and other lower
balance loans would be subjected to any substantive testing. Second, the
lower balance loans would pull the average balance down and result in
selecting even more of the commercial and other higher balance loans for
substantive testing. The objective of this alternative method of determining
individually significant is to define that amount which allows stratification of
high monetary amounts relative to the population. When multiple or
disparate populations are included, the method will not work.
12.22 After the population is defined, stratify it into layers. Ordinarily, no more
than ten strata are required to analyze the composition of the population.
Divide the largest item in the population by one less than the required
number of strata to determine the interval.
12.23 After the population is stratified, the audit team can use the data to define
an individually significant amount. Remember, this is the amount above
which all items will be tested so it should not be set so low that a large
number of items will be selected, nor should individually significant be set
at an amount that exceeds the average balance in the population plus two
standard deviations. Ordinarily, the amount will fall somewhere between
the average balance of the population plus one or two standard
deviations.
Identification and Examination of Key Items
12.24 The audit team may also identify key items (items with qualitative
characteristics, such as those that are unusual, prone to error, or have
other identified risks). Key items also may include items that are large in
amount, but not necessarily individually significant. The identification and
examination of these key items provide important audit evidence,
frequently in conjunction with other audit tests. For example, in Horizon,
the low risk strategy usually calls for the application of this procedure, in
conjunction with appropriate analytical procedures and tests of individually
significant items.
12.26 To assure the effectiveness of this procedure, the audit team should
define the key items during the risk assessment process. Further, the
audit team member, who reviews the client's records to identify the key
items for testing, should be suitably experienced and understand the entity
and its environment. An inexperienced staff member may select
inappropriate items for testing or fail to identify items that should be tested.
12.28 The underlying records are usually available in electronic form, therefore,
use of CAATs using IDEA is strongly recommended to help identify items
to be tested.
12.29 Once key items are identified, they should be adequately tested. Inquiries
of client personnel without obtaining supporting evidence are inadequate
to justify reliance on the procedure. However, scrutiny of the population,
with a determination that no key items were identified may form a basis for
reliance, if the procedure is appropriately documented.
12.30 The following guidance may be helpful to the audit team in considering the
adequacy or appropriateness of the tests suggested by Voyager:
Where a large amount of a population's value consists of only a few
items, testing those items and reviewing the rest against expectations,
perhaps testing some, will often provide as much audit reliance as a
sample and will cost less than a sample.
For reasonably possible risks where controls will not be tested or
control tests have failed, statistical sampling is the preferred response
because it provides a supportable estimate of error.
There may be other situations influenced by the audit team's view of
the likelihood of errors, such as when the entity focuses attention only
on major accounts. For example, if the entity has four major
customers, and keeps these under scrutiny, while paying significantly
less attention to the rest, the audit team may be concerned about
errors in the smaller accounts and wish to use direct testing to address
the risk of misstatement in the smaller accounts, rather than restrict
testing to the major customers.
When the sample size is small, other tests of details or substantive
analytical procedures should be considered, because the reliability of
the results of small samples is questionable.
If the sample size is very large, the decision to sample should be
reconsidered to determine if there is a more efficient way to obtain the
necessary audit evidence (e.g., CAATs using IDEA). If the audit team
decides that the sampling is appropriate, the sample size calculator
inputs should be reexamined to ensure that a sample is not being
selected based on incorrect inputs or assumptions.
12.31 The extent to which the audit team places reliance on audit evidence
derived from tests of details varies according to the circumstances. In
general, it is a function of:
the effectiveness of the particular procedure, and
the scope of the procedure (i.e., the number and monetary value of the
items examined)
12.33 When considering the extent of audit evidence required to support risks
associated with the valuation – gross assertion, the number of items
examined is usually less relevant than the monetary value of the items
examined. Tests of higher proportions of a population's value provide
greater assurance with respect to the valuation assertion, and can often
be designed to give greater assurance as to existence and ownership
rights as well.
12.34 In Horizon, tolerable error is the precision measure for the application of
audit procedures.
Now the data is ready to interrogate using the power of IDEA. In most
circumstances, we would go to “Field Statistics” at this point and finish our
task of defining individually significant. However, for this entity, we still
have some work to do to get the data organized for our use. We can
review the field statistics to learn more information about the data. Click on
“Field Statistics” to review field statistics for selected numeric fields.
Verify the total of the “Net Balance” field is $130,538,040 that agrees to
the total of the original Excel file. If we review the field statistics for the
“Net Balance” population, we notice significant negative balances, which
are skewing the statistics. A quick inquiry of the client and a scan of the
data identify the problem. Many customers are listed several times as they
have more than one loan and payments are sometimes reflected as a line
item rather than a reduction of the loan. We can summarize the data by
customer and solve this problem. To do this, click on the Menu item
“Analysis”. Then click on “Summarization” from the drop down menu that
appears. The following interface appears:
Select “Short Name” as the field to summarize. Next, select “Net Balance”
as the numeric field to total. Click the “Fields” button to select the fields
that we want to see in the summarization. “Short Name” and “Net
Balance” are enough as we are only interested for this demonstration in
defining individually significant items.
When we click “OK”, IDEA will create a summarization of the data, which
appears as follows:
Now when we click on “Field Statistics” we see the following statistics:
Note the total of the “Net Balance” field is still $130,538,040 but now there
are no negative balances. The data is summarized in a form that is very
usable to us in defining individually significant. IDEA has totaled the
population and determined that the individual items range from $1,750 to
$6,000,000. The average amount is $672,876. The standard deviation is
$1,105,629. Now we can stratify this data and use this information to
define individually significant.
From this information, IDEA produces the table below. We can now move
to the final step and define individually significant.