An inquiry should be combined with inspection or reperformance for more accurate results. Monthly amounts will generally be more effective than annual amounts and comparisons by location or line of business usually will be more effective than company-wide comparisons. The level of detail that is appropriate will be influenced by the nature of the client, its size and its complexity. Generally, the risk that material misstatement could be obscured by offsetting factors increases as a client’s operations become more complex and more diversified. 8/ For purposes of this standard, the term “audit of financial statements” refers to the financial statement portion of the integrated audit and to the audit of financial statements only. The ability of the auditor to perform the necessary audit procedures to cover the remaining period. This type of test of control can provide us better evidence comparing to inquiry and observation.

Internal auditors typically conduct substantive testing at regular intervals throughout the year. External auditors often get hired to conduct substantive testing once a year, usually at the end of the year. Won’t automatically uncover all irregularities, auditors may use tools like tests of control to test the systemic operating controls. If the controls are operating efficiently, the control risk is low. However, if they are found to be weak or ineffective, the control risk is high. This means that the auditor will have to perform additional tests during the audit. Many auditors assess control risk at high and use a fully substantive approach.

Footnote (AS 2305 – Substantive Analytical Procedures):

The company or auditor doesn’t detect initial errors when the financial process and reporting begin. In auditing related party transactions, the auditor is not expected to determine whether a particular transaction would have occurred if the parties had not been related or what the exchange price and terms would have been. The auditor should identify related party transactions in audit planning. An accounting estimate approximates a financial statement element, item, or account without exact measurement. For example, to test the completeness assertion, expected sales for some entities might be developed from production statistics or square feet of selling space. For other entities, data relevant to the assertion of completeness of sales may not be readily available, and it may be more effective or efficient to use the details of shipping records to test that assertion. 3/ Paragraphs 12–13 of Auditing Standard No. 12 discuss the auditor’s responsibilities regarding obtaining an understanding of the company’s selection and application of accounting principles.

• Likewise, if you are examining subsequent period receivable collections, some time must pass before you do so.
• This is due to the observation may only give assurance that procedures are performed properly by the client when being observed at a point in time.
• Inspection is the process of examination of supporting documents related to control procedures.
• Vouch the selected sale transactions to sale invoices, shipping documents, and sale orders.
• These transactions have more chances of inaccuracy because they are with the parties that are related to the owners/ directors of the company.
• Then they provide this audit opinion in the form of an audit report which accompanies the financial statements of the company in the annual report.

Internal control testing is normally done at the audit planning as required by the standard, but in practice, the internal control testing might be done at the execution stages. Test of controls is part of System Based ApproachandSubstantive Procedures Audit Approach. If the control is strong and effectively https://online-accounting.net/ implemented by management, then the risks of material misstatements are likely to be low whether those risks are from errors or fraud. Those internal controls are mainly related to internal control over financial reporting. This refers to the how timing can affect the acceptable level of risk.

Example: test of controls for sales

Doing so allows us to determine the what, when and how of our procedures. The audit standards refer to this as the nature, timing and extent. So, here is the way to design appropriate responses to your client’s risks of material misstatement. By contrast, if the internal controls for receivables are strong, then assess control risk for the existence assertion at less than high, and test controls for effectiveness. (You do, however, have the option to perform substantive tests rather than test controls, even when controls are appropriate. On the other hand, if the controls are weak and not effective in preventing or detecting risks of material misstatements, the control risk will be high. In this case, we will need to increase our substantive tests in order to reduce the audit riskto an acceptable level.

Some techniques used to test controls can also be used to test transactions and financial statement balances. For example, parallel simulations, the test data method, the embedded audit module, and the integrated test facility can be used for both control test of control vs substantive test testing and substantive testing. Another common procedure used during revenue audits is controls testing. Its role is to prevent, correct or detect material misstatements by examining a company’s internal controls that affect financial reporting.

Substantive Procedures in Auditing: Definition & Explanation

These are the substantive analytical procedures and tests of details. Analytical procedures are an important method performed while conducting the process of auditing. In the analytical procedures, the evaluations are made on the financial statements by studying the plausible relationships between financial and non-financial data. For example, computation of ratios, comparing past year balances with the current year, etc. TOC is a type of audit procedure we perform to evaluate whether a client’s internal control works effectively.

Substantive procedures generally provide persuasive evidence when they are designed and performed to obtain evidence that is relevant and reliable. Also, some types of substantive procedures, by their nature, produce more persuasive evidence than others. Inquiry alone does not provide sufficient appropriate evidence to support a conclusion about a relevant assertion. Auditors often use substantive procedures for revenue assessment to detect fraud or financial information misstatement. Their goal is to determine whether or not your account balances and transactions are valid, accurate and complete. When it comes to different substantive audit procedures that auditors can apply during the course of the audit, they can use two types of substantive audit procedures.

Substantive Procedure

Auditors must use their professional judgment to determine whether they should perform a test of details on sales. Test of details refers to collecting evidence that helps evaluate the correctness of the account balances, disclosures, and other accounting transactions made by the business entity in their financial statements. For each inherent risk factor identified in part as presenting risk at the assertion level, identify a significant financial statement account at risk of material misstatement, and a relevant management assertion for the risk and account identified. As a source of assertions to consider, refer to the PCAOB list of assertions in Exhibit 1, plus the cutoff assertion as used by North Central CPAs. Other inherent risks affect specific accounts in the financial statements and are referred to as risks at the assertion level. For example, a mining company may have incentive to understate its less successful mineral reserve explorations to avoid losing investors.

A robust internal control system is essential for businesses to keep their financial records accurate. As the assessed risk of material misstatement increases, the evidence from substantive procedures that the auditor should obtain also increases. The evidence provided by the auditor’s substantive procedures depends upon the mix of the nature, timing, and extent of those procedures. Further, for an individual assertion, different combinations of the nature, timing, and extent of testing might provide sufficient appropriate evidence to respond to the assessed risk of material misstatement.

In applying these assertions and definitions, North Central CPAs has expanded the PCAOB list of management assertions to include the cutoff assertion. The cutoff assertion addresses the proper recording of transactions in the period when they actually occurred, as well as the proper omission of transactions that did not take place during the current period. Shortening the audit process – if a controls test shows that internal controls are effective, and are able to prevent errors or fraud in financial statements, this can eliminate the need for additional audit actions. Reliable means that internal control can detect major kinds of risks that could materially affect the financial statements. And in order to assess, the auditor needs to design internal control testing on those significant control and make a conclusion. Traditionally, tests of details of balances have focused more on financial statement assertions that pertain to balance sheet accounts than on income statement accounts.

If the initial test does not prove effectiveness, then you have to expand your sample or just punt—in other words, use a fully substantive approach. If your tests do not support effectiveness, expand your sample size and examine additional receipts. Or skip the tests and move to a fully substantive approach. Regardless, if controls are not effective, consider the need to communicate the control deficiency to management and those charged with governance. Furthermore, you believe completeness is a relevant assertion.