Chapter 9

Substantive Procedures and the

Financial Statement Audit

Prepared by Richard J. Campbell

Copyright 2011, Wiley and Sons

 Learning Objectives
1. Recognize the audit associations of transaction cycles,
account balances, management assertions, and audit steps.
2. Understand the reasons an audit opinion is limited to
reasonable assurance.
3. Learn to draw conclusions from the results of audit tests of
account balances.
4. Understand the audit documentation appropriate for
substantive tests and procedures.

Chapter 9 -1
 Learning Objectives
5. Become familiar with specific topics that are particularly
important to financial statement audits, for example,
estimation processes, going-concern considerations, and
period-end cutoff.
6. Learn the substantive tests and procedures that are
important for the various financial statement accounts.

Chapter 9 -2
 TRANSACTION CYCLES AND ACCOUNT BALANCES

 Transaction cycles can be defined differently for different

businesses and industries, but generally most businesses
have a cycle dealing with
• Sales or sources of revenue and cash receipts
• Purchases or acquisitions and cash disbursements
• Human resources
• Production or inventory, which, when necessary includes
cost accounting
• Activities that are financing related, such as investment,
debt, and equity transactions

Chapter 9 -3 Learning Objective #1

 Substantive Procedures on Accounts and Disclosures

EXHIBIT 9-1

Chapter 9 -4 Learning Objective #1

 MATERIALITY AND REASONABLE ASSURANCE

 Sampling is used for tests of details of balances

 Errors in audit tests and procedures are either
nonsampling or sampling errors
 Sampling error can also occur on an audit when
the selected sample does not represent the
population

Chapter 9 -5 Learning Objective #2

 MATERIALITY AND REASONABLE ASSURANCE

Chapter 9 -6 Learning Objective #2

 Analytical Procedures, Fluctuation Analysis

EXHIBIT 9-2

Chapter 9-7 Learning Objective #2

 Audit Risk Model

AR stands for audit risk

RMM is the risk of material financial
statement misstatement
IR stands for inherent risk
CR stands for control risk

DR stands for detection risk.

TD is the risk that a material misstatement will be
missed by the auditor’s tests of details of balances.
AP is the risk that a material misstatement is
missed by the audit’s analytical procedures

Chapter 9 -8 Learning Objective #2

 PERFORMING SUBSTANTIVE TESTS AND PROCEDURES

 Auditors perform substantive tests using tests of details of

balances and substantive analytical procedures
 A general description of the initial steps for a test of details
of balances using a sample is as follows:
1. Determine which account and assertion is being evaluated
2. Decide what audit procedure needs to be used to test the
assertion
3. Decide on the sampling method.
4. Decide on the sampling frame, or physical population from which
the sample is selected, and the sampling unit.

Chapter 9 -9 Learning Objective #2

 PERFORMING SUBSTANTIVE TESTS AND PROCEDURES (Part 2)

5. Determine the method to select the sample, such as utilizing

identifying numbers produced by a random number generator,
systematic sampling with a random start, or haphazard
sampling.
6. Determine the sample size needed.
7. Select the sample, perform the test, and identify discrepancies
8. Evaluate the sample results.

Chapter 9 -10 Learning Objective #2

 Conclusions as a Result of Substantive Tests and Procedures:
Evaluating Results

Steps to evaluate an account balance based on an audit test of

a sample are summarized as follows:
1. Determine the recorded amount of the sample.
2. Using evidence collected from the sample, investigate the
misstatements.
3. Using the sample as a basis, estimate the “true” account balance.
4. Set a tolerable misstatement
5. Evaluate whether the account balance is materially misstated and
requires an adjustment
6. Consider the impact of the audit findings on other accounts, fraud
risk, and ICFR.

Chapter 9 - 11 Learning Objective #3

 Quantitative Evaluation of Sample Results

EXHIBIT 9-3

Chapter 9-12 Learning Objective #3

 Quantitative Evaluation of Fishtrackers’ Inn Outcome

EXHIBIT 9-4

Learning Objective #3
Chapter 9-13
 Quantitative Evaluation of Fishtrackers’ Inn Outcome

EXHIBIT 9-4

Learning Objective #3
Chapter 9-14
 AUDIT DOCUMENTATION

 Lead schedule is the term for the audit work

paper that lists and specifies the components
that make up the line item on the working trial
balance.
 Detailed work papers support the information on
the lead schedule, providing information about
the audit tests performed on each component of
the trial balance line item and results of the tests.

Chapter 9-15 Learning Objective #4

 Work Paper Examples
EXHIBIT 9-5

Chapter 9-16 Learning Objective #4

 Work Paper Examples

Chapter 9-17 Learning Objective #4

 IMPORTANT CONSIDERATIONS IN A FINANCIAL STATEMENT AUDIT

Estimates

Chapter 9-18 Learning Objective #5

 Fair Value Measurements and Disclosures

Chapter 9-19 Learning Objective #5

 Illegal Acts

Learning Objective #5
Chapter 9-20
 Related Party Transactions

Learning Objective #5
Chapter 9-21
 Going Concern

Chapter 9-22 Learning Objective #5

 AREAS ADDRESSED IN A FINANCIAL STATEMENT AUDIT

EXHIBIT 9-6

Examples of Audit
Steps for Cash

Chapter 9-23 Learning Objective #6

 AREAS ADDRESSED IN A FINANCIAL STATEMENT AUDIT

Chapter 9-24 Learning Objective #6

 Receivables

Chapter 9-25 Learning Objective #6

 Receivables

Chapter 9-26 Learning Objective #6

 Inventory

Chapter 9-27 Learning Objective #6

 Inventory

Chapter 9-28 Learning Objective #6

 Investments, Emphasis on Marketable Securities

EXHIBIT 9-9

Chapter 9-29 Learning Objective #6

 Investments, Emphasis on Marketable Securities

Chapter 9-30 Learning Objective #6

 Current Payables

EXHIBIT 9-10

Examples of
Audit
Steps for
Accounts
Payable

Chapter 9-31 Learning Objective #6

 Long-Term Debt

EXHIBIT 9-11

Examples of
Audit
Steps for Long-
Term
Debt

Chapter 9-32 Learning Objective #6

 Long-Term Debt

Chapter 9-33 Learning Objective #6

 SUMMARY OF SUBSTANTIVE TESTS AND PROCEDURES

Chapter 9-34 Learning Objective #6

 APPENDIX A: STATISTICAL TECHNIQUES AND TESTS OF DETAILS
OF BALANCES

EXHIBIT A9-1

Characteristics
and
Sample Size

Chapter 9-35 Appendix A

 APPENDIX A: STATISTICAL TECHNIQUES AND TESTS OF DETAILS
OF BALANCES

EXHIBIT A9-2
Confidence
Coefficients

Chapter 9-36
Appendix A
 APPENDIX A: STATISTICAL TECHNIQUES AND TESTS OF DETAILS
OF BALANCES

EXHIBIT A9-3

Results of the
Sample
and Audit Analysis

Chapter 9-37 Learning Objective #3

 Review Question

Which of the following audit processes will the auditor

have to wait until the end of the fiscal year, or after, to
perform?
(a) Observing the inventory count
(b) Testing the operating effectiveness of the yearend
closing and reporting process
(c) Inquiring of the client and identifying related parties
(d) Evaluating the possibility of illegal acts

Chapter 9-38
 Review Question
Regarding illegal acts, which of the following
is not true?
(a) The auditor is more likely to become aware of illegal acts that
have a direct impact on the financial statements.
(b) The auditor does not have to follow up on
material illegal acts that he or she becomes
aware of as long as they do not have a direct
effect on the financial statements.
(c) Illegal acts are one of the topics that is covered in the
management representations letter.
(d) All of the above are true.

Chapter 9-39
 Review Question
Which of the following is not important to
the auditor regarding related party
transactions?
(a) Adequacy of disclosure of material
related party transactions
(b) Material misstatement of any of the
transactions because they are not arms
length
(c) Identifying all the related parties so that
the related party transactions and financial
statement disclosure can be evaluated
(d) All of these are important to auditing
related party transactions.

Chapter 9-40
Copyright

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