Chapter 10 Substantive Tests of Transactions and Balances Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-1 Learning Objective 1: Relationship Between Evidence Gathering Procedures • Auditor has to obtain sufficient appropriate evidence to support the audit opinion • Tests of controls (chapter 9) and substantive tests of transactions and balances are the main evidencegathering procedures • Auditor selects most efficient and effective combination of audit procedures that allows them to achieve audit objective • Assertions are used to help them in their risk assessment of material misstatement, and to direct their audit procedures to the assessment of these risks Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-2 Relationship Between Tests of Controls and Substantive Tests of Transactions • Most controls are built around transaction flows • Tests of controls: transactions selected to test whether related controls are working Does not directly measure monetary error in accounting records • Substantive test of transactions: transactions selected to determine whether monetary errors have occurred Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-3 Dual Purpose Tests • These are tests of transactions that address both control and substantive matters simultaneously • Very common in practice since both tests of controls and substantive tests of transactions involve inspection of documents • It is efficient to perform tests of control and substantive tests on transactions selected simultaneously, e.g select document and check evidence of authorisation (test of control) and recompute amount (substantive test of transaction) Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-4 Relationship Between Substantive Tests of Transactions and Balances • Objective of substantive tests is to reduce detection risk • Substantive tests of transactions focus on the individual transactions that make up the balance • Substantive tests of balances substantiate the ending balance of an account (which is comprised of multiple transactions) Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-5 Distinguishing Between Substantive Tests of Transactions and Substantive Tests of Balances • The $5000 balance for Able could be verified by confirming this balance with customer (test of balances) or verifying to supporting documentation the three transactions comprising this balance (tests of transactions) Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-6 Learning Objective 2: Financial Report Assertions and Substantive Audit Procedures • The auditor develops specific audit procedures to evaluate and address the risk of material misstatement for both classes of transactions and events, and account balances • The risk associated with each assertion is assessed, and substantive audit procedures are directed at specific assertions based on this assessment Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-7 Assertions about Transactions and Events (Income Statement Accounts) • • • • • Occurrence: in testing whether transactions that generated financial report accounts actually occurred Completeness: the auditor identifies evidence indicating items that should be included in the class of transactions and investigates whether they are, in fact, included Accuracy: relates to determining the appropriate recording of the dollar value and other information of transactions Cutoff: involves checking that transactions are recorded in the correct period Classification: in designing substantive tests for the assertion of classification, the auditor considers the appropriate classification of the item in the financial report Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-8 Assertions about Account Balances at Period End (Balance Sheet Accounts) • Existence: the auditor selects from items contained in the accounting records and obtains evidence that supports them • Rights and obligations: the auditor must ascertain that the assets are owned/controlled by the client and that the liabilities are those of the client • Completeness: the auditor identifies evidence indicating items that should be included in the account balance and investigates whether they are in fact included • Valuation and allocation: the auditor considers the appropriateness of the basis of valuation of the asset or liability and the basis of any allocation of this valuation across accounting periods Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-9 Existence/Occurrence and Completeness Assertions Note that the direction of testing determines whether existence/occurrence or completeness assertion is tested existence (of account balance components)/ occurrence (of transactions in accounting records) Source Documents Accounting Records Completeness (of accounts balance components or transactions in accounting records) Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-10 Learning Objective 7: Non-Current Assets • The balances of non-current asset accounts are usually affected by a few relatively large transactions each year • For this reason, it is usually efficient for auditors to verify account balances by performing tests on individual transactions Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-34 Property, Plant and Equipment • Assertions of interest are generally: – – – existence rights and obligations valuation and allocation Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-35 Property, Plant and Equipment: Key Procedures • Substantiating additions and identifying retirements; • Considering any revaluations; • Analytically testing and recomputing related expense accounts such as depreciation Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-36 Assertions, Objectives and Procedures for Property, Plant and Equipment Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-37 Investments and Intangible Assets • Assertions generally of interest are: – – – Rights and obligations Existence Valuation and allocation Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-38 Assertions, Objectives and Procedures for Investments Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-39 Intangibles – Use of Experts • Assertions in relation to existence, valuation and allocation for intangible assets are particularly subjective given the nature of intangible assets • Auditor may consider the use of experts where issues are outside of auditor’s own expertise Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-40 Investments and Intangibles: Key Procedures Physical examination Confirmation Inspection of legal documents Recomputation, vouching, tracing • Specialised valuation procedures • • • • Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-41 Learning Objective 8: Non-Current Liabilities and Owners’ Equity: Key Procedures • Key assertion: – completeness • Key procedures: – – – – confirmations reading minutes of meetings examination of contracts and agreements inspection of share registers Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-42 Assertions, Objectives and Procedures: Non-Current Liabilities Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-43 Learning Objective 9: Income Statement Accounts: Assertions of Interest • In a double-entry accounting system, testing one side of a transactions automatically tests the other side • A procedure that achieves an audit objective for one side of a transaction should achieve a comparable audit objective for the other side • For example, if the auditor verifies the existence of an accounts receivable balance, this will verify the occurrence of the related sales transactions • For this reason the extent of substantive tests of transactions is negatively related to the amount of substantive testing of balances that is undertaken Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-44 Audit Procedures for Income Statement Accounts • Substantiation indirectly by simultaneous tests of accounts, e.g sales → accounts receivable; • Substantiation directly in conjunction with balance sheet accounts, e.g plant & equipment → depreciation • Substantiation directly by analytical procedures, e.g relationships following a predictable pattern such as sales → sales commission • Substantiation directly by separate tests of individually significant transactions, events or account balances, e.g discontinued operations Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-45 Learning Objective 10: Auditing by computer: Testing clients’ files • The major way the auditor uses the computer for substantive tests involves using audit software to read clients’ master files and/or transactions files • Major advantages: – – Directs auditor’s attention to items of risk and/or materiality; Undertakes routine audit tasks efficiently Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-46 Functions of Audit Software • This software can interrogate clients’ files in order to: – – – – – – select sample items; identify records meeting specified criteria (exception reporting); test and make calculations; compare data in separate fields or on separate files; summarise data; write reports Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-47 Auditing by Computer: Four Major Techniques • Generalised audit software – audit interrogation software used with many clients; • Specialised audit software – audit interrogation software especially written for client, task or industry; • Utility programs – software or hardware designed to accomplish common routine tasks, e.g sort, merge; • Systems management programs – enhanced productivity tools (e.g data retrieval software) typically part of sophisticated operating systems environments Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant Gay and Roger Simnett Slides prepared by Roger Simnett 10-48 ... of transactions: transactions selected to determine whether monetary errors have occurred Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia... documentation the three transactions comprising this balance (tests of transactions) Copyright  2006 McGraw-Hill Australia Pty Ltd Revised PPTs t/a Auditing and Assurance Services in Australia 3e by Grant... substantive tests on transactions selected simultaneously, e.g select document and check evidence of authorisation (test of control) and recompute amount (substantive test of transaction) Copyright