University of New South Wales

School of Accounting
Auditing and Assurance Services
2021
Seminar Seven
Substantive Tests II
Tests of Detail in IT Systems
Substantive Analytical Procedures
Subsequent Events and Going Concern
 Seminar Overview
• In this seminar, we will cover some more
advanced issues in substantive testing.
• In particular, we will cover
– Performing tests of details in IT systems
– Substantive analytical procedures
– Testing subsequent events
– Assessing the going concern assumption

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 Module One

Substantive Testing in an IT
Environment

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 Substantive Testing in IT
• If data is stored in a computerised
accounting system, a computer can be
used to help perform substantive tests on
it.
– Necessary because the data is not readable
by humans
– Much quicker
– Many routine tasks can be automated.

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 Generalised Audit Software
• Generalised audit software (GAS) is a
computer program that performs
substantive tests
– GAS belongs to the auditor.
– It processes the clients files.
– It works with standard accounting software file
formats (that’s why it’s generalised)

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 GAS Tasks
• GAS automates routine tasks, such as:
– Selecting sample items,
– Identifying records meeting specified criteria
(exception reporting),
– Performing and testing calculations,
– Comparing data in separate fields or separate
tables/files,
– Summarising data,
– Report writing.

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 Exception Reports
• One way to conduct substantive tests is to
identify the unusual transactions or
balances and investigate them.
• Finding them can be a very costly and
time consuming process.
• This process can be automated by the use
of computer generated exception reports.

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 Exception Reports
• An exception report is a report where the
items are selected based on one or more
criteria. For example:
– Select all debtors who have not paid for more
than 90 days,
– Select all sales that are over $1,000,
– Select all orders who do not have a customer
number that appears in the Customers table.

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 Exception Reports and Audit
Strategy
• Exception reports change the testing
strategy
– The computer does the time consuming and
mechanical task of finding the exceptions.
– The auditor does the more judgment based
investigation of the exceptions.
• Thus, the use of exception reports allows
far more efficient use of the auditor’s time.

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 Effects of GAS on Substantive
Testing Strategy
• Larger samples can be tested.
– Sometimes all items are tested.
• As many routine tasks can be automated,
the auditors role is now one of interpreting
evidence, rather than gathering it.
• Overall, less audit effort is required to
achieve the same level of confidence.

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 Module Two

Substantive Analytical Procedures

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 Substantive Analytical
Procedures
• There are two types of substantive
procedures:
– Tests of detail,
– Substantive analytical procedures.
• They are both equally valid methods of
gathering audit evidence about:
– $ amounts,
– Disclosures.

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 Tests of Detail
• The most basic type of audit test is the test
of detail.
• Tests of detail involve:
– Selecting a sample of items.
– Testing the items in the sample.
– Noting the errors.
– Based on these errors making an estimate of
the overall error in the account.

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 Substantive Analytical
Procedures
• The Relevant standard is
– ASA 520 Analytical Procedures
• For purposes of the Australian Auditing Standards, the
term “analytical procedures” means evaluations of
financial information through analysis of plausible
relationships among both financial and non-financial
data. Analytical procedures also encompass such
investigation as is necessary of identified fluctuations or
relationships that are inconsistent with other relevant
information or that differ from expected values by a
significant amount. (ASA 520.4)
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 Substantive Analytical
Procedures
• Substantive analytical procedures involve:
– Estimating the balance of an account using
mathematical relationships between it and
• Other financial information
– Depreciation has a mathematical relationship with
property plant & equipment
– Interest expense has a mathematical relationship with
interest bearing liabilities
• Non financial information
– Production capacity constraints and other physical
limitations.

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 Requirements
• When designing and performing substantive
analytical procedures, either alone or in
combination with tests of detail, as substantive
procedures in accordance with ASA 330 the
auditor shall:
– (a) Determine the suitability of particular substantive
analytical procedures for given assertions, taking
account of the assessed risks of material
misstatement and tests of detail, if any, for those
assertions;

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 Requirements
– (b) Evaluate the reliability of data from which the
auditor's expectations of recorded amounts or ratios
is developed, taking account of source, comparability
and nature and relevance of information available and
controls over preparation;
– (c) Develop an expectation of recorded amounts or
ratios and evaluate whether the expectation is
sufficiently precise to identify a misstatement that,
when individually or aggregated with other
misstatements, may cause the financial report to be
materially misstated; and

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 Requirements
– (d) Determine the amount of any difference of
recorded amounts from expected values that is
acceptable without further investigation as required by
paragraph 7 of this auditing standard
• ASA 520.5

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 Investigation of Results
• If analytical procedures performed in accordance with
this Auditing Standard identify fluctuations or
relationships that are inconsistent with other relevant
information or that differ from expected values by a
significant amount the auditor shall investigate such
differences by:
– (a)Enquiring of management and obtaining
appropriate audit evidence relevant to management's
responses; and
– (b) Performing other audit procedures as necessary in
the circumstances.
• ASA 520.7
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 Hotel Room Income
• ABC Ltd owns a large hotel in the centre of
Sydney.
• Its trail balance contains a figure of $12.1 million
for room income.
• Is this correct?
• Tests of detail could be used.
– Refer to testing sales in previous seminar.
• However, substantive analytical procedures will
be more efficient.
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 Hotel Room Income
• There is a mathematical relationship between room
income and non financial information.
• Room Income = Number of rooms x Rate per room x
Occupancy Rate x 365
• Investigation reveals that the hotel has 200 rooms with a
room rate of $250 per night and it is 60% full on average,
room income should be
• 200 x 250 x 0.6 x 365 = $10.95 m
• This is $1.15 m below the reported figure.
• Is this a material error?
• A more complex calculation is needed.
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 Hotel Room Income
• Further examination reveals that the hotel has 20 suites
that have a room rate of $400 per night and a 70%
occupancy rate.
• Ordinary room income
– 180 x 250 x 0.6 x 365 = $9.855 m
• Suite income
– 20 x 400 x 0.7 x 365 = $2.044 m
• Total $11.899 m
• This is much closer to the reported figure of $12.1 m and
indicates that room income is not materially misstated.

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 Interest Expense
• Auditing of interest expense
– Tests of Details
• Select a sample of interest bearing liabilities, check that there
are journal entries for the expense (completeness) and that
the calculations are correct (accuracy).
– Substantive Analytical Procedures
• Split the interest bearing liabilities into classes.
• Use an average rate for each class to estimate interest for
that class.
• Sum up these class totals to estimate the overall total.
• Compare this amount to the amount of interest expense on
the trial balance, to see if there is a material difference.

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The Milfred Company Ltd - Overall Test of Interest Expense
Interest expense as per general ledger 31/12/05 17,539(1)
Computation of estimate:
Short-term loans:
Balance outstanding at month end: (2)
Jan 47,500
Feb 59,200
Mar 70,600
Apr 70,800
May 61,200
June 43,700
July 20,000
Aug —
Sept —
Oct 12,700
Nov 26,400
Dec 35,600
Total 447,700
======
Average (÷12) 37,300 @ 14.5% (3) 5,410
Long-term loans:
Opening balance 137,500 (2)
Closing balance 121,700 (2)
----------
259,200
======
Average (÷2) 129,600 @ 9.7% (4) 12,570
Estimated total interest expense 17,980 (5)
Differences (441)

Legend and comments:

(1) Agrees with general ledger and working trial balance
(2) Obtained from general ledger/verified to bank statements.
(3) Estimated based on examination of several notes throughout the year with rates ranging from
14% to 15%.
(4) Agrees with permanent file schedule of long-term debt.
(5) Difference not significant. Indicates interest expense is reasonable 24
 Reliance
• Extent of reliance placed on analytical
procedures, as substantive procedures,
depends upon:
– Risk of account misstatement,
– Materiality,
– Other audit procedures directed to the same
objective (and the nature of the account),
– Accuracy of analytical procedures,
– Evaluation of internal controls.

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 Reliance – Internal Controls
• Substantive analytical procedures use
mathematical formulae.
• The output will only be as good as the inputs.
• The input data is often drawn from a company’s
internal control system.
– In the hotel room example, the occupancy rate will
come from the hotel reservation system.
• Therefore, substantive analytical procedures are
most useful when internal controls are effective.

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 Reliance - Calculations
• Substantive analytical procedures use
mathematical formulae.
• Therefore, there must be something to calculate
– i.e. there must be a mathematical relationship
• This is often not the case, so substantive
analytical procedures are not used for many
accounts
• Tests of detail can be used for every account
and every assertion.

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 Analytical Procedures
• Analytical Procedures can be used for
– Planning
– Evidence gathering
• substantive analytical procedures
– Review of the audit
• Ratios, trend analysis, common size balance
sheets etc. can be used for planning and review
but they are NOT substantive analytical
procedures.

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 Examples
• How would you use analytical procedures
to estimate the following?
• In which cases is the use of analytical
procedures inappropriate and why?
– The wages bill for UNSW
– Sales for Woolworths
– Provision for doubtful debts at a bank.

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Module Three

Subsequent Events

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 Subsequent Events
• Subsequent events (events occurring after
balance date) are covered by two
standards.
– AASB 110 Events after the Reporting Period
• Accounting rules
– ASA 560 Subsequent Events
• Auditing rules

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 Subsequent Events
• Subsequent events means events
occurring between the date of the financial
report and the date of the auditor’s report,
and facts that become known to the
auditor after the date of the auditor’s
report.
– ASA 560.5(d)
• Note, there can be several weeks between
these two dates – a lot can happen!
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 Types of Subsequent Event
• AASB 110 discusses two types of subsequent
events (AASB 110.3)
– those that provide evidence of conditions that existed
at the end of the reporting period (adjusting events
after the end of the reporting period); and
• These are often called adjusting events. The financial
statements are adjusted to reflect their impact.
– those that are indicative of conditions that arose after
the end of the reporting period (non-adjusting events
after the end of the reporting period)
• These are often called disclosing events. They are disclosed
in the notes to the financial statements (Subsequent Events
note)

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 Key Dates
• There are four key date
– The balance date (usually 30th June)
– The date of the directors’ declaration
– The date the audit report is signed by the
engagement partner
• This is usually the same as the date of the
directors’ declaration.
– The date the financial statements are issued
• The auditor has different responsibilities in
each period
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 Prior to Date of Audit Report
• The auditor shall perform audit procedures
designed to obtain sufficient appropriate
audit evidence that all events occurring
between the date of the financial report
and the date of the auditor’s report that
require adjustment of, or disclosure in, the
financial report have been identified.
– ASA 560.6

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 After the Audit Report Date
• The auditor has no obligation to perform any
audit procedures regarding the financial
report after the date of the auditor’s report.
However, if, after the date of the auditor’s
report but before the date the financial report
is issued, a fact becomes known to the
auditor that, had it been known to the auditor
at the date of the auditor’s report, may have
caused the auditor to amend the auditor’s
report, the auditor shall …

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 After the Audit Report Date
• … the auditor shall:
– (a) Discuss the matter with management and,
where appropriate, those charged with
governance.
– (b) Determine whether the financial report
needs amendment and, if so,
– (c) Enquire how management intends to
address the matter in the financial report.
• ASA 560.10

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 Reponses
• Before the financial statements are issued.
• If management will fix error, do nothing.
– There is no longer a problem with the financial
statements.
• If management won’t fix error, issue
qualified audit report.

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 Reponses
• After the financial statements are issued.
• If management will fix error
– They must reissue financial statements.
– The auditor must issue a new audit opinion
• This opinion must contain an emphasis of matter
paragraph stating that this is a new audit report on
a revised set of financial statements.
• If management won’t fix error.
– The auditor should take (legal?) action to
prevent users from relying on the audit report.
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 Procedures (ASA 560.6 – 7)
• To find subsequent events, the auditor shall:
– Obtain an understanding of any procedures management
has established to ensure that subsequent events are
identified.
– Enquire of management and, where appropriate, those
charged with governance, as to whether any subsequent
events have occurred which might affect the financial
report.
– Read minutes, if any, of the meetings, of the entity’s
owners, management and those charged with governance,
that have been held after the date of the financial report
and enquire about matters discussed at any such
meetings for which minutes are not yet available.
– Read the entity’s latest subsequent interim financial
reports
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Module Four

Going Concern

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 Going Concern
• Going concern issues are covered by two
standards and the Corporations Act (2001)
• AASB 101 Presentation of Financial
Information
– Accounting rules
• ASA 570 Going Concern
– Auditing rules

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 Corporations Act (2001)
• s295(4) The directors’ declaration is a
declaration by the directors:
– (c) whether, in the directors’ opinion, there
are reasonable grounds to believe that the
company, registered scheme or disclosing
entity will be able to pay its debts as and
when they become due and payable; and …
• Note, there is other material in the director’s
declaration (see s295(4)(d) and s295(4)(e)).

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 AASB 101 s25
• When preparing financial statements, management shall
make an assessment of an entity’s ability to continue as a
going concern. An entity shall prepare financial statements on
a going concern basis unless management either intends to
liquidate the entity or to cease trading, or has no realistic
alternative but to do so.
• When management is aware, in making its assessment, of
material uncertainties related to events or conditions that may
cast significant doubt upon the entity’s ability to continue as a
going concern, the entity shall disclose those uncertainties.
• When an entity does not prepare financial statements on a
going concern basis, it shall disclose that fact, together with
the basis on which it prepared the financial statements and
the reason why the entity is not regarded as a going concern.

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 ASA 570
• Under the going concern assumption, an
entity is viewed as continuing in business
for the foreseeable future.
– ASA 570(2)
• In practice, “the foreseeable future” means
till the expected date of signing of the next
audit report
– This is usually (but not always) 12 months.

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 Going Concern
• Why is Auditor interested?
– Asset valuations
– Litigation risk
– Risk of management misrepresentation
– Legislative & professional duty
• ASA 570(6)
– May affect audit opinion
• ASA 570(21 – 23) and ASA 570 [Aus] Appendix 1
&2
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 Financial Factors
• Net liability or net current liability position.
• Fixed-term borrowings approaching maturity
without realistic prospects of renewal or
repayment
• Excessive reliance on short-term borrowings to
finance long-term assets.
• Indications of withdrawal of financial support by
creditors.
• Negative operating cash flows indicated by
historical or prospective financial report.
• Adverse key financial ratios.

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 Financial Factors
• Substantial operating losses or significant
deterioration in the value of assets used to
generate cash flows.
• Arrears or discontinuance of dividends.
• Inability to pay creditors on due dates.
• Inability to comply with the terms of loan
agreements.
• Change from credit to cash-on-delivery
transactions with suppliers.
• Inability to obtain financing for essential new
product development or other essential
investments.
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 Operating Factors
• Management intentions to liquidate the entity
or to cease operations.
• Loss of key management without
replacement.
• Loss of a major market, key customer(s),
franchise, license, or principal supplier(s).
• Labour difficulties.
• Shortages of important supplies.
• Emergence of a highly successful competitor.
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 Other Factors
• Non-compliance with capital or other
statutory requirements.
• Pending legal or regulatory proceedings
against the entity that may, if successful,
result in claims that the entity is unlikely to be
able to satisfy.
• Changes in law or regulation or government
policy expected to adversely affect the entity.
• Uninsured or underinsured catastrophes
when they occur.
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 Mitigating Factors
• (i) Assets
– Ability to sell eg. commercial property
– Delay capital acquisition
• (ii) Debt
– Overdraft facility, new lines?
– Rollover
• (iii) Equity
– Issue of share capital
– Loans/guarantees from associated companies
• (iv) Costs
– Ability to reduce costs

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