AUDITING

Substantive Testing

What is it?

Tests of transactions – gather evidence in relation to validity, completeness and accuracy of transactions.Trace source document to accounting records (journals and ledgers)Looking to ensure transaction actually took place; that is was recorded in the correct account for the correct amount

What is it? (write)

Tests of balances – review accuracy, validity and completeness of account balances– Debtors / creditors– Stock

Looking to ensure that assets and liabilities actually exist; that the company owns those assets and liabilities; that the balances were recorded at the correct value.

Procedure (write)

Analytical review – review relationships between figures and to highlight unusual trendsTrial Balance re-added and checked against P&LOpening and closing balances checkedReview journal entries and ledger postings

Testing (write)

Balance Sheet items:– Test liabilities for understatement– Test assets for overstatement– Test owners’ equity for overstatement

P&L items:– Test expenses for understatement– Test revenue for overstatement

Testing & Audit Objectives (pg 263)

Accuracy – recalculations, tracing, reconciliationsExistence and occurrence – inspection, observation, enquiry, analytical review, vouching tracing and confirmation of assets and balancesCompleteness – AR, completeness of balances between periods, tracing and vouching, cut-offs

Valuation and measurement – inspection, enquiry, recalculation and estimates of reasonablenessPresentation, disclosure and classification – inspection, confirmation, enquiryRights and obligations – check ownership of rights, confirmation , representation letters from solicitor

Substantive Audit Program (pg 264)

A list of procedures to be carried.How the procedures will be carried outA record of the work done (shown in the working papers that support the Program)See pg 265 and 266 for an example of a substantive testing program for the cash subsystem- Have the clients figures actually achieved the audit objectives with a degree of confidence

Reltionship b/w compliance & substantiative testing (pg 267)

The Auditor must consider the assessed level of inherent and control risk in determining the nature, timing and extent of substantive tests needed to reduce audit risk to an acceptable levelIf inherent risk and control risk is high substantive testing must be inhanced so as to reduce detection risk and maintain the overall audit risk at an acceptable level

AR =IR * CR * DRIf control risk is high compliance tests will cease and greater substantiative testing

will be performed to lower the detection risk (and therfore audit risk)

Even if inherent and control risk is low the auditor must still carry out some stubstantive testing

Substantiative testing

Substantiative testing is increased by:– Larger samples of transaction and balances– Further analytical review– Gaining a range of evidence – audit trail, enquiry,

confirmation in relation to each audit objective or assertion

– Raising materiality ie lowering the dollar value of items to be verified

Detection of errors & irregularities

Types of errors– Errors of principle – misapplication of accouning standards ie recording capital

expenditure as a expense• Adjusting Journal required to Dr Asset and Cr Expenses and adjustment for

depreciation so that assets are not understated and expenses are not overstated– Errors of timing – cut off tests ie goods invoiced prior to June 30th but not

recorded• Adjusting Journal required to Dr Accounts receivable and Cr Sales assets are not

understated and revenues are not understated– Miscalculations- arithmetical or data entry ie recording sales as $3200 instead of

$3400• Adjusting Journal required to Dr Accounts receivable $200 and Cr Sales $200 so that

assets are not understated and revenues are not understated

If the client refuses to amend the draft figures to adjust for a material error, the auditors may eventually qualify their report

Sales (chapter 15)

Select a number of entries in SJ and vouch to Source doc (sales invoice)Trace a number of sales invoices to the SJ and ledger accountsVerify arithmetic accuracy of sales invoice and SJReview SJ for large or unusual itemsPerform year-end cut-of test and prepare adjusting entries

Purchases

Select a number of entries in the PJ and vouch to source documentsTrace a number of supplier invoices to the PJ and ledger accountsPerform recalculations on supplier invoicesReview the PJ for large or unusual itemsPerform year-end cut-of test and prepare adjusting entries

Accounts Receivable

Verify Accs Rec T/B figure and reconcile to Gen Ledger acc and subsidiary ledgers.Confirm Accs Rec – letters are sent to various debtors asking them to confirm the balance as at 30 June.– Positive confirmations are used where the debtor is asked

to respond if they agree with the balance as well as if there is a difference.

Accounts Receivable

Vouch accounts receivable entries in accounting records to source documentsReview an aged analysis of debtors and check for debtors to 120 days.Review adequacy of Provision for Doubtful DebtsPerform Sales cut-off tests

Accounts Payable

Verify accuracy of accounts payable trial balance figure and reconcile to creditors’ balances subsidiary and general ledgerVouch recorded creditors to supporting documentationConfirm creditors – Confirmation letters sent out to creditors. Letters are sent to various creditors asking them to state the balance as per their records as at 30 June. Positive confirmations are used.

Accounts Payable

Perform purchases cut-off testsPerform cash payments cut-off tests

Inventory

Verify accuracy of schedules and perpetual records and agreement with inventory balancesObserve client inventory taking – be present at the client’s stocktakeVouch recorded purchases to supporting documentationEnquiry of management regarding ownership

Cash Receipts and Payments

Confirm bank and loan balances with the bankCount cash on handPrepare independent bank reconciliationPerform cash cut-off testsReview prepayments

Non-current assets

Verify accuracy of fixed asset register and agree fixed assets register with property, plant and equipment balancesRecalculate depreciation and accumulated depreciationInspect property, plant and equipment additionsVouch property, plant and equipment additions to registerVouch property, plant and equipment disposals/trade-ins to registerExamine title or lease documents

Payroll

Review payroll records and recalculate payrollRecalculate accrued wagesSelect a sample of transactions from the payroll register and vouch to the journal entries and general ledgerVerify payroll calculationsReview preparation of payroll tax and deductions

Investments

Send out Confirmation Letters to confirm balancesVerify accuracy of balances, schedules and Investment RegisterInspection of documentation – broker invoices, remittance advice for dividend income received and/or interest earnedVouch entries in investment accountsRecalculate interest earned

Long-Term Liabilities

Send out Confirmation Letters to confirm long-term debtReview documentation – debt authorisation and contracts and vouch to entries in accounting records.Analytical review

Shareholders’ Funds

Inspect share RegisterVouch entries to share capital accounts, retained profits and reservesReview Constitution of the companyCheck the share and equity issues have adhered to Corporations Law and other relevant legislative or technical requirements.Check that dividends are properly authorised.