Week 9

Question 1

Extent of substantive procedures:

Answer 1

Determined by risk assessment.
Trivial or immaterial accounts are either ignored or subjected to analytical procedures only.
Audit risk model used to make a risk assessment on each significant account or disclosure.

High IR, CR: do not rely on and test controls, use significant amount of substantive testing to reduce DR to acceptable level.
Low IR, CR: testing controls shows them to be effective, limited substantive testing required.

Question 2

Timing of substantive procedures:

Answer 2

Also determined by risk assessment.
Lower DR, more work done at year-end.
Audit firm must also consider availability of resources to conduct procedures around year-end.
Use techniques to influence schedule:
review events prior to year-end
e.g. acquisitions.
Review activity in period to date, e.g. review interim ageing of debtors then update at year-end.
Perform general audit procedures prior to year-end, e.g. read board minutes.
Review provisions prior to year-end, e.g. understand estimation processes used by management.
Leverage off internal audit (ASA 610; ISA 610).

Question 3

Matters to consider when designing substantive procedures:

Answer 3

Ensure procedures respond to specific risk faced by client from both IR and CR factors.
Different clients may have same overall level of risk but risk caused by different factors.
Procedures would be also different.
Take credit for work already done – early work in audit to assess risk also provides evidence.
Set appropriate testing thresholds – what the auditor considers important for an audit will vary depending on the overall risk assessment.

Question 4

Substantive testing of cash

Three most important assertions:

Answer 4

Existence:
usually addressed by bank confirmation (AGS 1002).

Completeness:
test bank reconciliation and cut-off of cash transactions
verify reconciling items to next period bank statement.

Classification:
important because of special disclosure requirements.

Question 5

Substantive testing of cash

Other assertions may also be important:

Answer 5

Rights and obligations:
assertion also significant where clients may pledge assets
pledging restricts client’s rights over cash.

Valuation and allocation:
usually only an issue when client has significant foreign currency bank accounts.

Question 6

Objectives in auditing cash

Answer 6

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Question 7

Process affecting cash:

Answer 7

Auditor assesses evidence obtained from interim testing on significant transactions, control testing.
When CR low, unlikely to do additional testing on cash receipts and payments, focus on balance.
If CR not low, substantive tests of receipts and payments may be required.

Question 8

Example substantive tests of transactions — cash:

Answer 8

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Question 9

Illustrative procedures for auditing cash:

Answer 9

Testing cash account balances always done at some level, additional procedures required as risk assessment increases.
Tests include bank confirmations, bank reconciliation re-performance, analytical procedures etc.

Question 10

Substantive testing of trade receivables

Important assertions:

Answer 10

Existence:
Usually addressed by debtors’ confirmation (ASA 505; ISA 505).
Positive confirmation:
auditor requests reply in all circumstances.
Negative confirmation:
auditor requests reply only if debtor disagrees with balance shown.
Usually addressed by debtors’ confirmation (ASA 505; ISA 505).
Confirmations do not provide assurance about valuation because they do not address recoverability.

Valuation and allocation:
Use subsequent receipts test.
Analytical procedures based on ageing.
Other assertions may also be important in the audit of trade receivables.

Classification:
Assertion can also be important because of disclosures, such as related parties and financial instruments.

Rights and obligations:
Can also be important because of restrictions on trade terms.

Completeness:
Can be addressed through cut-off testing.

Question 11

Objectives in auditing trade receivables:

Answer 11

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Question 12

Processes affecting trade receivables:

Answer 12

There are three important transactions that impact on the balance of trade receivables:
sales
sales Returns and Allowances
cash receipts.
Auditor would only consider these procedures if unable to test and rely on controls or it is deemed more efficient to test balance substantively

Question 13

Example substantive tests of transactions – trade receivables:

Answer 13

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Question 14

Illustrative procedures for auditing trade receivables

Answer 14

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Question 15

Substantive testing of inventory

Two most important assertions:

Answer 15

Existence
Usually addressed by testing client’s annual or cyclical stock take (ASA 501; ISA 501).
Auditor tests client’s verification of physical inventory with records, and auditor must sight inventory.
Lower CR, less likely stocktake is performed only annually.

Valuation and allocation:
Lower of cost and NRV - AASB 102 (IAS 2).
Sighting inventory at stock take allows auditor to assess slow-moving, damaged, obsolete, impaired, excess stock which should be written down.
Typical techniques:
vouching to invoices to verify initial cost
vouching to sales details to verify cost of sales
test provision for impairment calculations.

Question 16

Other assertions may also be important in the audit of inventory:

Answer 16

Completeness:
not usually a major issue
risk of understatement can be issue where goods sold on consignment.

Rights and obligations:
Relevant for some clients due to consignment sales, complex purchasing contracts.

Classification:
usually addressed by testing stock listing, allowing verification of disclosures

Question 17

Principal objectives in auditing inventory:

Answer 17

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Question 18

Processes affecting inventory:

Answer 18

There are three important types of transactions that impact on the inventory balance:
purchasing
cash payments
inventory processes.
Usually, auditor relies on control testing of these transactions to confirm low CR.
If CR not low, substantive tests required for the transactions.

Question 19

Illustrative procedures for auditing inventory:

Answer 19

Testing inventory account balances required by ASA 501; ISA 501, Para 4.
If inventory is material to the financial report, auditor must attend the physical inventory counting, unless impracticable, to:
Evaluate managements’ instructions and procedures.
Observe performance of count.
Inspect inventory
Perform test counts

Auditor is required to test entity’s final inventory records to determine if they accurately reflect actual inventory count.

Auditor will also usually:
perform analytical procedures
test valuation of inventory
test client procedures to assess inventory impairments due to damage
test client’s costing methods
use procedures to test valuation of inventory at remote locations (e.g. use another auditor).

Question 20

Substantive testing of property, plant and equipment

Answer 20

PPE refers to the property, plant and equipment of an entity.
PPE are often referred to as fixed assets.
Fixed asset register:
is a list of all the items of PPE that an entity
used to capture additions and disposals
calculates the depreciation charges and track cost and written down value of each item.

Question 21

Substantive testing of property, plant and equipment

Two most important assertions:

Answer 21

Existence:
Verify items recorded in client’s fixed asset register.
Physically sight assets listed in first audit and periodically.
Focus on additions and disposals in later years.

Valuation and allocation:
Evidence about condition gathered when sighting physical assets.
Consider cost and fair value and asset impairment.
Change in client operations could impact fair values.
Vouch initial cost to invoices and contracts.
Valuation and allocation:
Vouch disposals to sales contracts, receipts.
Test depreciation through reasonableness testing of charge based on useful lives.

Question 22

Other assertions may also be important in the audit of PPE:

Answer 22

Completeness:
not usually major issue

Rights and obligations:
Initial test then periodically.
Registered titles, registration papers.
Consider leased items.

Classification:
Generally test fixed asset register.

Question 23

Principal objectives in auditing property, plant and equipment:

Answer 23

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Question 24

Processes affecting property, plant and equipment:

Answer 24

There are three important types of transactions that impact on the balance of PPE:
cash receipts 
cash payments
purchasing.
Substantive testing when CR high.

Question 25

Illustrative procedures for auditing property, plant and equipment:

Answer 25

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Question 26

Substantive testing of payables

Answer 26

Two most important assertions are:
completeness
valuation and allocation.

For both assertions:
Major risk is understatement.
Use subsequent payments testing.
Vouch payments after balance date to invoices to verify invoices dated prior to year-end are included in payables.
Cut-off testing.

Select sample of purchases either side of year-end and verify that each included or excluded from payables based on invoice date.

Existence and rights and obligations:
Not usually important because they relate more to risk of overstatement.

Classification:
Important if there are related party transactions, and specific finance types that require disclosures.
Accruals are treated in same way as payables, search for unrecorded amounts through subsequent payments testing.

Question 27

Principal objectives in auditing payables:

Answer 27

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Question 28

Processes affecting payables:

Answer 28

There are two important types of processes that impact on the balance of payables:
cash payments
purchasing.
Substantive testing when CR high.

Question 29

Illustrative procedures for auditing payables:

Example substantive tests of account balances – payables:

Answer 29

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Question 30

Special considerations for auditing other balance sheet accounts

Answer 30

Most other accounts are typically audited substantively because they do not rely on high volume processes and specific application controls. 
These account balances include:
prepayments
investments
taxation
provisions
leases and equity.

Question 31

Assessing the results of substantive procedures

Answer 31

Auditor’s objective is to identify and quantify any errors:
understand why error occurred
assess need for additional testing
make final estimate of misstatement, assess materiality and recommend adjustments.