Week 8

Question 1

Substantive procedures and assertions:

Answer 1

Nature, timing and extent of audit procedures responds to risk assessment for each significant account and assertion.
Audit risk model: AR = f(IR, CR, DR) (first introduced in chapter 4).
Risk of material misstatement (IR, CR) is inverse to the level of DR auditor will accept.
Substantive procedures reduce DR.
If IR and CR are low, auditor will accept a high DR, and small number of substantive procedures are required.

Question 2

Linkage between IR, CR and DR

Answer 2

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Question 3

Risk assessments are required to be performed at assertion level (ASA 315; ISA 315):

Answer 3

Assertions can be stated as audit objectives:
Management assert that sales transactions recorded in income statement occurred and relate to the entity.
Auditor’s objective is to verify that recorded sales transactions exist.

Transaction assertions are related to account balance and disclosure assertions.
Work done to verify sales occurrence provides some evidence about accounts receivable existence

Question 4

Audit assertions

Answer 4

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Question 5

Definition of substantive procedures:

Answer 5

Audit procedures that are designed to detect material misstatements at the assertion level.
They are used to obtain direct evidence as to the completeness, accuracy, and validity of data, and the reasonableness of the estimates and other information contained in the financial report.

Audit program documents substantive procedures the auditor plans to use to identify and rectify material errors before giving the audit opinion.
Nature, timing and extent of substantive procedures in audit program determined by:
risk of material misstatement
timing considerations affect nature of substantive test (e.g. access during interim periods)
level of assurance necessary (reasonable or limited)
type of evidence required (how persuasive)
complexity of client’s data systems.

Question 6

Relationship between risk assessment and the nature, timing and extent of substantive procedures

Answer 6

The nature of substantive testing varies from account to account and consists of one or a combination of techniques, including:
key items testing
representative testing
other test of transactions/underlying data
analytical procedures.

Question 7

The appropriate mix of substantive procedures depends on:

Answer 7

the nature of the account balance

the risk assessment for the specific account and the client overall.

Question 8

Timing of substantive procedures:

Answer 8

Influenced by level of control risk.
Typically at or near year-end, exceptions include:
Accounts that accumulate transactions that mostly remain in year-end balance.
E.g. additions to fixed asset register.
Control testing confirms a strong control system.
Roll-forward procedures are suitable due to strong controls and no changes to controls.
roll-forward procedures are done between interim date and year-end
provide evidence that interim testing results continue to apply for the remainder of the period.

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Question 9

Tests of details

Answer 9

Substantive tests other than analytical procedures.
Designed to verify a balance or transaction with supporting documentation.
Often referred to as either vouching or tracing.

Vouching: taking a balance or transaction from the underlying accounting records and verifying it by agreeing the details to supporting evidence outside of the accounting records of the company.
Primarily tests existence/occurrence assertion.

Tracing: tracking a source document to the accounting records.
Primarily tests completeness assertion.

Question 10

Key item testing:

Answer 10

Identify key items in a balance.
Usually select largest transactions within a balance to obtain ‘coverage’ of the total.
The more persuasive other evidence available, the less coverage key items have to address.

Representative sampling:
If further testing required after selecting key items.
Select items that are representative of population.
Sampling strategy depends on auditor’s expectations of error and overall audit objective.
I.e. testing primarily for over or understatement of balance).

Other tests of transactions/underlying data:
Tests of client prepared schedules.
Tests performed at interim date with roll-forward procedures.
Tests of underlying data to be used as part of analytical procedures.
Tests of income statement accounts for account classification.

Tests of individual transactions by vouching (agreeing) to supporting documents

Question 11

Analytical procedures:

Answer 11

Primary (persuasive) tests of a balance.
Corroborative tests in combination with other procedures.
To provide at least some minimal level of support for the conclusion.
Analytical procedures can be the most effective test of a balance, or at least reduce extent of other substantive tests (ASA 520; ISA 520).

Question 12

Types of analytical procedures:

Answer 12

Absolute data comparisons (prior year, budgets etc.).
Ratio analysis (activity, liquidity, profitability, leverage).
Trend analysis (over several accounting periods).
Common-size financial reports.
Break-even analysis.
Pattern analysis and regression (most sophisticated).

Testing the reliability of underlying data:
Mitigate risk of accepting account as not misstated when it is materially misstated.
Consider relevance of analytical procedures, they are less useful:
when client’s operations are diverse
if industry data is unreliable or not comparable to client
when severe inflation
when client’s budget process not well-controlled.

Consider reliability of data:
E.g. test reliability of ageing of debtors reports.
Do control tests suggest data is reliable?
Consider controls over non-financial data (e.g. tonnes).

Substantive analytical procedures — summary:
Identify computation, comparison, to be made.
Assess reliability of any data to be used.
Estimate probable balance or outcome.
Perform computations using internal or external data.
Compare estimated amount with calculation, assess if any difference is significant.
Determine appropriate procedures for investigating reasons for the difference
Perform procedures
Draw conclusions

Question 13

Performing substantive testing using computers:

Answer 13

Computer assisted audit techniques (CAATs) assist auditors with their testing in complex tasks. There are two main categories.

Question 14

Performing substantive testing using computers:

A

Answer 14

Software used to interrogate and examine client files (software can be special programs or spreadsheets).
Re-adding, performing logic tests, select key items and representative samples.
Handle large volumes of data and be more comprehensive.

Question 15

Performing substantive testing using computers:

B

Answer 15

Software that individual firms use to plan, perform and evaluate audit procedures, regardless of whether client automated or not.
CAATs are more useful when client controls are stronger.

Question 16

Levels of evidence

Answer 16

Evidence from different types of substantive procedures varies in persuasiveness.

Question 17

Persuasive evidence:

Answer 17

is suitable as primary test of balance
provides a reasonable estimate of balance, enabling auditor to conclude whether or not the account balance is free from material errors
no further procedures required.

Question 18

Examples of analytical procedures that provide persuasive evidence:

Answer 18

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Question 19

Corroborative evidence

Answer 19

Confirms audit findings from other procedures.
Supports management representations or otherwise decreases the level of audit scepticism.
Allows auditor to limit extent of other procedures in the area.
Unexpected results would require auditor to expand other substantive audit procedures to provide explanation of result.

Question 20

Examples of analytical procedures that provide corroborative evidence:

Answer 20

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Question 21

Minimal evidence

Answer 21

Not persuasive or corroborative.
E.g. simple comparison with previous year to help identify problems, not to reduce other testing.
Usefulness of procedure to generate more persuasive evidence depends on circumstances such as complexity of client and extent of fluctuations in particular account balance.

Question 22

Examples of minimal evidence

Answer 22

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Question 23

General: evidence

Answer 23

Analytical procedures might provide persuasive evidence in one circumstance but not in another.
On the other hand, another client’s portfolio might be more diversified and turn over quite rapidly.

Question 24

Evaluating and documenting substantive analytical procedure results

Answer 24

Auditor’s understanding of the client’s business helps identify likely fluctuations in financial data.
E.g. Seasonal trends, dependent relationships, specific business decisions.
Expectations of likely fluctuations helps auditor to interpret results.
Absence of fluctuation could be suspicious than a large fluctuation.

Question 25

Evaluating and documenting substantive analytical procedure results

Evaluating errors identified in testing:

Answer 25

Evaluating errors identified in testing:
Auditor assesses impact of all errors identified during the audit and documented in working papers.
Distinguish between errors (including fraud) and judgmental misstatements.
Differences in judgement between auditor and client.
Likely to be focus of discussions between auditor and client, more likely to be ‘range’ than exact number.
Decide if one-off event, or systematic errors.

Question 26

Evaluating and documenting substantive analytical procedure results

Concluding and documenting the results of substantive procedures:

Answer 26

The auditor has determined the nature, timing and extent of the substantive procedures, these are documented in the audit program.
This program then serves as the instructions for the audit team members to complete the required testing.