ACC 3600 Week 8: Substantive Testing & Audit Procedures

Substantive Procedure Definition

An audit procedure designed to detect material misstatements at the assertion level.

Audit Risk Model Formula

AR = IR × CR × DR (Audit Risk = Inherent Risk × Control Risk × Detection Risk).

High Inherent and Control Risk Effect

Auditor accepts lower detection risk, requiring more substantive testing.

Low Inherent and Control Risk Effect

Auditor accepts higher detection risk, requiring fewer substantive procedures.

Balance Assertions

Existence, rights & obligations, completeness, accuracy, valuation & allocation, and presentation.

Transaction Assertions

Occurrence, completeness, accuracy, cut-off, classification, and presentation.

Categories of Substantive Procedures

Substantive analytical procedures and tests of details.

Substantive Analytical Procedures Definition

Evaluating financial info by analyzing plausible relationships between financial and non-financial data.

Audit Stages for Analytical Procedures

Planning, audit execution, and audit completion.

Advantage of Analytical Procedures

Cheap, quick, easy, and efficient for high-volume predictable transactions.

Disadvantage of Analytical Procedures

Less persuasive because they rely on aggregated data and may hide individual errors.

Steps in Designing Analytical Procedures

1. Determine suitability, 2. Assess data reliability, 3. Develop expectations, 4. Set threshold, 5. Investigate variances.

Persuasive Analytical Evidence

Reliable enough to be the primary test and may eliminate the need for further testing.

Corroborative Analytical Evidence

Supports findings obtained from other audit procedures.

Tests of Details Purpose

To verify transactions or balances directly to supporting documentation.

Tracing (Source to Records)

Tests completeness and detects understatement.

Vouching (Records to Source)

Tests occurrence and detects overstatement.

Cut-off Testing Purpose

Tests that transactions are recorded in the correct accounting period.

External Confirmations

Independent evidence obtained from third parties; the most reliable form of audit evidence.

Timing of Substantive Procedures

Generally performed at or near year-end when misstatement risk is highest.

Roll-forward Procedures

Procedures performed to confirm interim test results remain valid for the remaining period.

Extent of Substantive Testing and Detection Risk

Low detection risk requires more evidence and larger sample sizes.

CAATs in Substantive Testing

Computer Assisted Audit Techniques increase coverage, test entire populations, and improve efficiency.

Judgemental Misstatement Examples

Allowance for doubtful debts, inventory impairment, or asset valuation.

Audit Program Purpose

Documents the nature, timing, and extent of planned substantive procedures.

Revenue Primary Risk

Overstatement due to material volume, management pressure, and fraud vulnerability.

Key Assertions for Revenue

Occurrence, accuracy, and cut-off.

Revenue Vouching Direction

Sales journal to invoice to shipping document; tests occurrence.

Revenue Tracing Direction

Sales order to shipping to invoice to journal; tests completeness.

Primary Risk for Expenses

Understatement, because it artificially inflates profit.

Key Assertions for Expenses

Accuracy, completeness, cut-off, and classification.

Cash Key Risk and Assertion

Existence risk (cash being overstated or stolen due to high liquidity).

Most Reliable Test of Details for Cash

Bank confirmation.

Key Assertions for Accounts Receivable

Existence and accuracy, valuation & allocation.

Most Important Accounts Receivable Procedure

Debtor confirmations.

Inventory Valuation Rule

Recorded at the lower of cost and net realizable value (NRV).

Required Procedure for Material Inventory

Attendance at the physical stocktake.

PPE Key Assertions

Existence, accuracy, and valuation & allocation.

Accounts Payable Main Risk

Understatement (unrecorded liabilities make the company look financially stronger).

Accounts Payable Key Assertion

Completeness.

Most Important Accounts Payable Procedure

Search for unrecorded liabilities.