CHAPTER 8 – SUBSTANTIVE TEST

 Substantive test – substantiate and detect MM

o Test of details
 Of transactions
 Of balances
o Substantive Analytical Procedure
 Analytical Procedure
o Enables the auditor to obtain CORROBORATIVE evidence
o Comparison of fin info wt the expectation
o When significant fluctuations are identified  conduct further investigation
 Inquiry
 Corroboration of mgmt responses
o Acceptance of fluctuation w/o investigation is affected by the materiality and
desired level of assurance
o Suitability of SAP
 Effectiveness is affected by NRPP
 Nature of assertion
 Reliability of the basis in developing expectation
 Precision of expectation
 Predictability of account
 More applicable for large volume of transaction that are predictable
 Income statement accounts
 Accounts not subject to mgmt’s discretion
 Relationships under a stable environment
 Test of Details
o Examining the actual details making up the various accounts
o Test of details of transactions and test of details of balances
o test of details of balances
 Tests directly the ending balance
 Count COH/obtain bank recon
 Large volume of immaterial amts
o Test of details of transactions
 Tests the transactions wc give rise to the ending balance
 Impractical
 Small volume of material ammounts
 Effectiveness of Substantive test
o Nature
 Quality of evidence
 Takes into consideration the cost of obtaining high quality evidence
o Timing
 Interim or at year end
 Interim
 Less effective, incremental risk of auditing interim balances
 Higher the risk, timing should be closer to YE
 Helps to resolve matters earlier on
 Allows work to be spread throughout the year wc minimizes
workload during peak periods
o Extent
 Amount of evidence needed
 Based on Materiality, Assessed level of risk, Degree of assurance
  The higher the risk of MM, the more extensive the substantive procedures
are
 Substantive Test and Test of Control
o TOC
 Evidence that provides that a misstatement is likely to occur
 Assessed level of CR
o Substantive Test
 evidence about the existence of misstatement
 acceptable detection risk
o result of TOC is a major factor in determining the nature, timing, and extent of
auditor’s substantive test
o dual purpose test – performing TOC and Test of Details concurrently
AUDIT EVIDENCE
-Information obtained in arriving at the conclusion wc the audit opinion is based. -
Underlying Accounting Data & Corroborative Information -
Obtained from performing TOC and Substantive Tests
 Underlying Accounting Data
o Accounting records that supports the FS
o Given by the management
 Books of accounts
 Reconciliation
 Worksheet
 Acctg manuals
 Corroborative information
o Documents and other info that supports the acctg data
o Obtained from the mgmt. and other sources
 Invoices
 Bank statements
 Purchase order
 Contract
 Checks
 Obtained by the auditor himself
 Quality of Evidence
o Sufficiency
 Amt of evidence that the auditor should accumulate
 Professional judgement to determine the amt needed
 Factors when evaluating sufficiency (CMR)
 Competence – more competent evidence, lesser evidence
 Materiality of the item – more material, more evidence
 Risk in an account – higher the risk, more evidence
o Appropriateness
 Measure of quality
 Relevance + Reliability
 Relevance
 Timeliness
 Ability to satisfy an objective
 Reliability
 Objectivity
 Source and nature
 Generalizations (WIDE) more reliable if from
 o Written form
o Independent sources
o Directly obtained by the auditor
o Effective acctg and IC system
 Cost-benefit consi
o Economically useful:
 w/i reasonable time
 at a reasonable cost
o evidence that is persuasive is enough
 meaning, even if a different auditor will audit—the same will have the
same conclusion
AUDIT DOCUMENTATION
-evidence should be documented
-working papers are records kept that documents the -
-procedures applied -
-info obtained -- -
conclusions reached
 Functions of WP
o Primary (ORA)
 Supports opinion
 Supports auditor’s representation (that audit was conducted in accordance
w the PSA
 Assist the auditor in planning, performance, review and engagement
o Secondary
 Plan future audits
 For other services
 Adequate defense in case of litigation
 Form. Content, Extent
o Document matters that are important
o Consider what would make an experienced auditor having no connection w the
audit understand
 Nature, timing, scope of audit proc
 Results of the proc and evidence obtained
 Significant matters arising and conclusions reached
o Factors
 NIESNNA
 Significance of aud ev
 Identified risk of MM
 Extent of judgement required
 Nature of the audit procedure
 Nature and extent of exceptions
 Need to document conclusions
 Audit methodology used
o Required to be documented (SEN)
 Significant matters discussed w the mgmt.
 Exception circumstances (departure from basic principle or essential
procedure)
 How the alternative procedure achieve the objective
 The reasons for the departure
 Nature, timing, extent of audit procedure
  Who did the audit, date completed
 Who reviewed, date and extent of review
 Classification
o Permanent
 Continuing significance
 Useful not just for the current audit period
 AOI & bylaws
 Analysis of LT accounts
 Engagement letters
 Internal control analyses
 Org charts
 Major contracts
o Current File
 Relevant only for a particular year
 Includes
 Financial Statement Copy
 Lead Schedules
 Audit Program
 Working Trial Balance
 Detailed Schedules
 Correspondence w other parties
 Ownership of WP
o Owned by the auditor, mgmt. has no rights
o May serve as reference for the client but not part not substitute of client’s records
 Confidentiality
o Code of Ethics of Professional Accountants
o Cannot be shown to third parties but is overridden by the statute of law
 Required by law, subpoenaed by law
 Professional right to disclose (when auditor is sued by the client)
 Retention
o Retained for a period of time enough to meet the needs of his practice and satisfy
the legal requirement
 Guidelines
o Heading
o Indexing
o Cross indexing
o Tickmarks
Attendance at Physical Inventory
 Material
o Attend physical inventory counting
 Inspecting inventory to ascertain existence and evaluate condition
 Perform test counts
 From inventory records to physical count (vice-versa)
 Completeness and alidity
o Test accuracy of records
 Physical count before or after yearend
o Obtain audit evidence abt whether changes are properly recorded
o Testing the design, implementation, and maintenance of control
 Physical attendance is impracticable
 o Perform alternative procedures to obtain evidence abt the EXISTENCE &
CONDITION
 Failure to do so will cause the issuance of a qualified/disclaimer opinion
 Inventory held by third parties
o If material, existence and condition thru
 Confirmation to third parties
 Inspection of documents abt these inventory
ACCOUNTING ESTIMATES
-approx amt when there is no precise means of measurement -
examples
 Warranty obligation
 Inventory obsolescence
 Loss contingencies
 Dep’n and amort’n
 Percentage of completion of cons cont
 All for credit losses
 Fair value of securities not publicly traded
 Auditor’s responsibility
o Management- make estimates
o Auditor- obtain evidence that
 Acctg estimate is accounted for and disclosed
 Acctg estimate is reasonable
o Disclosed- requires knowledge of business and AFRF
o Reasonableness, factors to consider
 Significant to the estimate
 Sensitive to variations
 Apparent deviations
 Subjective/prone to bias
o Reasonableness
 Review and test the process by mgmt.
 Make independent estimate
 Review subsequent events
RELATED PARTIES
 Includes
o Another entity wc has control or SI over the client
o An entity wc the client has control or SI over
o Entity wt common control
 Controlling ownership
 Owners are close family members
 Common KEY management
 Aud’r should be aware bc
o FRF requires disclosure
o Motivated by other than ordinary business consi
o Give rise to MM
 Mgmt’s responsibility
o Identify and disclose RP
o Implement acc and IC system designed to identify and disclose RP
 Aud’r’s responsibility
 o Obtain an understanding of RP relation’p and transactions sufficient to assess the
risk of MM and conclude whether the FS is fairly presented
o May cause MM
 Obtain information abt RP by making inquiry abt
o The identity of RP (inc’g changes)
o Nature of the relation’p
o Whether transactions occurred, type and purpose
 Indicates a RP trans’n
o Abnormal terms of trade
o Lack of an apparent logical business reason
o Substance differs from form
o Processed in a bias manner
o High volume/significant trans’n compared to others
o Unrecorded trans’n
 Obtain evidence that the RP rel and trans’n is identified and disclosed. IF there are RP
trans’n outside of the entity’s normal course of business:
o Obtain understanding of the business rationale, terms
o Audit evidence that such trans’n is authorized and approved
 Written rep’n
o Completeness of info
o Adequacy of RP disclosures
EXPERT
 Types
o Auditor’s expert
 Work wt the auditor
 Assists in obtaining sufficient appropriate evidence
 Type:
 Internal expert
 External expert
o Management’s expert
 Work wt the mgmt.
 Assists in the prep’n of the fs
 Determining the need for an aud’rs expert
o Whether mgmt. has used an expert
o Nature and significance
o Risk of MM
o Expected nature of proc to respond to the risk
o Availability of alternative sources
 Evaluating the aud’s expert (CFTR)
o Competence and Objectivity
o Understand Field of Expertise
o Establish terms
o Evaluate Results
 If aud is not satisfied
 Should agree on terms abt the addtl aud proc
 Should perform further audit proc
 Evaluate the mgmt’s expert
o Competence, Capability, Objectivity
 Reliability of the work
 o Understand expert’s field
 Reading the engmt’s letter
 Make inquiries
Evaluate the appropriateness of the expert’s work
 Relevance and reliability
 Should support the assertion in thefs
 Reliance on the expert’s aud report
o Aud’r has sole responsibility, not reduced by the use of expert’s work
o Opinion
 Unmodified: should not make reference to the e’s work
 Modified: can make reference if necessary to explain
 Should indicate in the report that such refernce does not reduce the
aud’s resp
Internal Audit
 Performs assurance and consulting activities
 To evaluate and improve the effectiveness of governance, risk mgmt., IC processes
 Aud’r should obtain understanding abt the IA to assist in planning and developing
effective aud function
 Important phases:
o Preliminary assessment of internal aud’g
o Evaluating and testing the work of IAud’g
 Preliminary Assessment
o Competence
 Attainment and maintenance of knowledge and skills
 Professional qualification and experience
 Policy on hiring, training, and professional development
o Objectivity
o Due Professional Care
 Has systematic and disciplined approach to plan’g perform’gg supervisi’g,
review’g, docu’g the internal audit act
 Evaluate and test the work of IA
o Will be done if the audr decides to use the work of the IAudr
o Would consider whether
 Performed by compentent person
 Suff app evidence is obtained
 App conclusions are reach
 Exceptions are resolved
o PSA 260 requires the EA to
 Read reports abt functions that the audr plans to use
 Determine the adequacy of IA’s work
 Note
o All judgement shall be that of the EAud’s
o Responsibility will not be reduced
o Audr’s report shall not include any reference to the work