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Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 1
CHAPTER 10:
SUBSTANTIVE TESTS OF TRANSACTIONS
AND BALANCES
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 2
RELATIONSHIP BETWEEN TESTS OF
CONTROLS AND SUBSTANTIVE TESTS OF
TRANSACTIONS
• Most controls built around transaction flows.
• Tests of controls: transactions selected to test whether related controls are working.
• Substantive test of transactions: transactions selected to determine whether monetary errors have occurred.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 3
DUAL PURPOSE TESTS • These are tests of transactions that address both
control and financial misstatement issues 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 on transactions selected simultaneously, e.g. select document and check evidence of authorisation (test of control) and recompute amount (substantive test of transaction).
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 4
SUBSTANTIVE TESTS OF
TRANSACTIONS AND BALANCES
• Objective is to provide reasonable assurance of validity and propriety of financial report or identify monetary misstatements and thus reduce detection risk of auditor.
• 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.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 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).
Extract from Accounts Receivable Subsidiary Ledger
Customer Year-end Balance Transactions for Able
Able 5000 Sales 2000
Receipts (1000)
Sales 4000
Baker 500
Chan 1000
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 6
FINANCIAL REPORT ASSERTIONS OF INTEREST
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 7
EXISTENCE/ OCCURRENCE AND
COMPLETENESS ASSERTIONS
Note that the direction of testing determines whether existence/occurrence or completeness assertion is tested.
Source
Documents
existence (of account balance components)/
occurrence (of transactions in accounting records)
Accounting
Records
Completeness (of accounts balance components or
transactions in accounting records)
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 8
DETERMINANTS OF AUDIT
PROCEDURES USED
Will be determined by:
• The assertion/audit objective to be tested
• The nature of the item and available evidence
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 9
CASH, CASH RECEIPTS AND CASH
PAYMENTS — ASSERTIONS OF PRIMARY
INTERESTS
Cash Cash receipts/payments
• Existence;
• Completeness; and possibly
• Valuation (if foreign currency balances).
• Occurrence
• Completeness; and possibly
• Measurement (if foreign currency transactions).
These are primarily:
- since these are areas where misstatement is most likely to occur
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 10
APPROACH IN AUDITING CASH
BALANCES
• Determined by assessed level of control risk in bank and cash handling procedures.
• Much of this information will come from evaluations and tests of controls in the sales and cash receipts, purchases and cash payments systems.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 11
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR CASH BALANCES
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 12
CASH — KEY PROCEDURES
These are:
• Testing of client’s bank reconciliation
• Obtaining confirmation of bank balances from client’s bankers
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 13
SALES, CASH RECEIPTS, ACCOUNTS
RECEIVABLE — ASSERTIONS OF
INTEREST
Sales/cash receipts
Accounts receivable
•Occurrence
•Measurement
•Existence
•Valuation
- as these are areas in which misstatement is most likely to occur
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 14
ACCOUNTS RECEIVABLE — KEY
AUDIT PROCEDURES
• Confirmation • Subsequent receipts review • Cut-off • Analytical procedures • Tests of sales transactions • Review of aged trial balance
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 15
ASSERTIONS, OBJECTIVES AND
PROCEDURES FOR SALES AND ACCOUNTS
RECEIVABLE
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 16
ACCOUNTS RECEIVABLE —
CONFIRMATION AND OTHER PROCEDURES
Auditor might plan to obtain direct confirmation from debtors using:
• Positive form — asks client to respond, whether or not they agree with information as to amount owed in request
• Negative form — requests client to respond when they disagree with amount shown
Auditor should also consider other procedures such as examining evidence of subsequent cash receipts, and examining sales and shipping documents.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 17
FORMAT OF POSITIVE ACCOUNTS RECEIVABLE
CONFIRMATION REQUESTS
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 18
CONFIRMATION PROCEDURE VERSUS
SUBSEQUENT CASH RECEIPTS TESTING
Subsequent cash receipts commonly viewed as superior form of evidence because achieves both key assertions.
Confirmations Subsequent cash receipts testing
•Existence YES
•Valuation NO
•Existence YES
•Valuation YES
Confirmations still require tests of likelihood of payment (doubtful debts provision).
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 19
PURCHASES AND INVENTORY
• Inventory consists of goods to be sold or used in the production of saleable goods.
• Transactions involving inventory: increase to inventory when goods purchased and decrease to inventory when goods sold.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 20
RISK ASSESSMENT OF
INVENTORY
Inventory generally considered high risk
because:
• Significant to determination of income
• High volume of activity
• Accounting complexities
• Possibility of manipulation in this area
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 21
INVENTORY — ASSERTIONS
OF INTEREST
Two key assertions of inventory are
generally:
• Existence
• Valuation
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 22
INVENTORY — KEY
PROCEDURES
• Observation of physical inventories
• Analytical procedures
• Cut-off
• Tests of pricing and summarisation
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 23
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR PURCHASES AND INVENTORY I
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 24
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR PURCHASES AND INVENTORY II
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 25
INVENTORY — OBSERVATION OF
PHYSICAL INVENTORY: STOCKTAKE
• Where inventory is considered material, auditor should attend physical inventory count (stocktake), unless impractical.
• When attending stocktake, auditor uses a combination of observation and inquiry and making test counts.
• If inventory outside auditor’s area of expertise, should consider utilising services of expert.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 26
INVENTORY — TESTS OF PRICING AND
SUMMARISATION OF COUNT PROCEDURES
A combination of vouching, tracing and recomputation. In performing these procedures auditor’s main concerns are:
• Identifying obsolete, excess and slow-moving items
• That inventory is counted correctly and results of inventory count are updated correctly
• That prices for goods are applied appropriately
• That inventory is valued at the lower of cost and net realisable value
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 27
ACCOUNTS PAYABLE AND
PAYMENTS
• Primary assertion of concern is completeness, as most likely form of misstatement is understatement.
• Common audit procedures to address this assertion are confirmation, a search for unrecorded liabilities and analytical procedures performed on related expense account balances.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 28
ASSERTIONS, OBJECTIVES AND
PROCEDURES OF ACCOUNTS PAYABLE
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 29
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 auditor to verify account balances by performing tests on individual transactions.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 30
PROPERTY, PLANT AND
EQUIPMENT
Assertions of interest are generally: • Existence • Rights and obligations • Valuation
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 31
PROPERTY, PLANT AND
EQUIPMENT — KEY PROCEDURES
• Substantiating additions and identifying retirements
• Considering any revaluations
• Analytically testing or recomputing related expense accounts such as depreciation
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 32
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR PROPERTY, PLANT AND EQUIPMENT
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 33
INVESTMENTS AND
INTANGIBLE ASSETS
Assertions generally of interest are:
• Rights and obligations
• Existence
• Valuation
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 34
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR INVESTMENTS
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 35
INTANGIBLES — USE OF EXPERT
• Assertions in relation to valuation and existence for intangible assets are particularly subjective given nature of intangible assets.
• Auditor may consider use of experts where issues are outside auditor’s own expertise.
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 36
INVESTMENTS AND INTANGIBLES
— KEY PROCEDURES
• Physical examination
• Confirmation
• Inspection of legal documents
• Recomputation, vouching, tracing
• Specialised valuation procedures
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 37
NON-CURRENT LIABILITIES AND
OWNERS’ EQUITY
Key assertions completeness:
Key procedures:
• Confirmations
• Reading minutes of meetings
• Examination of contracts and agreements
• Inspection of share registers
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 38
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR NON-CURRENT LIABILITIES
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 39
STATEMENT OF FINANCIAL
PERFORMANCE ACCOUNTS:
ASSERTIONS OF INTEREST
• Occurrence
• Completeness
• Rights and obligations
• Measurement
• Disclosure
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 40
AUDIT PROCEDURES FOR STATEMENT OF
FINANCIAL PERFORMANCE ACCOUNTS I
• Substantiation indirectly by simultaneous tests of statement of financial performance accounts, e.g. sales accounts receivable; cost of goods sold inventory
• Substantiation directly in conjunction with statement of financial position accounts, e.g. property, plant & equipment depreciation
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 41
AUDIT PROCEDURES FOR STATEMENT OF
FINANCIAL PERFORMANCE ACCOUNTS II
• Substantiation directly by analytical procedures, e.g. relationships between amounts that are expected to follow a predictable pattern such as sales sales commission
• Substantiation directly by separate direct tests of individually significant transactions or events or account balances of intrusive interest, e.g. discontinued operations
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 42
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 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 43
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 — routines written by manufacturer for hardware, e.g. sort, merge
• Systems management programs — enhanced productivity tools (e.g. data retrieval software) typically part of sophisticated operating systems environments
Copyright 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 44
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 2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett 45
EFFECT OF STRATEGIC BUSINESS
RISK ON SUBSTANTIVE TESTS
• Increased emphasis on tests of controls for routine transactions implies decreased emphasis for substantive tests for such transactions.
• Increased emphasis on non-routine transactions implies increased emphasis on substantive tests, as would not expect sophisticated control systems around non-routine transactions.
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