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Auditing- A Practical Approach

Chapter 8: EXECUTION OF THE AUDIT – PERFORMING SUBSTANTIVE PROCEDURES

FMGT 4310

Auditing 2

Chapter 8 Learning Objectives 1. Define substantive audit procedures

2. Understand the link between the audit risk model and the nature, timing, and extent of substantive procedures

3. Provide examples of different substantive audit procedures

4. Explain the different levels of audit evidence obtained when performing substantive procedures

5. Describe the documentation of the conclusions reached as a result of performing substantive procedures 8-2

What are “substantive procedures”?

8-3

Tests of details to detect

Misstatements

OVER, or

UNDER

8-4

- inspection (physical examination) - confirmation - observation - enquiries of client - reperformance - recalculation - analytical procedures

Types of evidence

8-5

CAIRORE

Substantive Procedures

• Can we complete an audit using ONLY substantive procedures?

• Yes, but…

8-6

audit risk

= x x inherent

risk control

risk

planned detection

risk

Risks of Material Misstatement

Substantive Procedures Audit Risk Model

8-8 Copyright John Wiley & Sons Canada, Ltd.

Nature, extent of timing of substantive procedures is determined by: RMM- Risk of material misstatement

–Level of assurance needed? –Persuasiveness of evidence

available? –Complexity of client systems

8-9

Substantive Procedures

e.g., Warranty provision – risk that some claims are omitted is higher than risk of incorrect measurement of identified claims

• Affects both extent and timing of tests

– For warranty provision

» More extensive tests of completeness assertion needed than valuation & allocation assertion

» Completeness tests more likely near year end, valuation & allocation tests of identified claims could be done at interim date

8-10

Substantive Procedures

Primary risk of OVERSTATEMENT or UNDERSTATEMENT?

When to perform? what is CR assessment?

–Typically at YE –If at interim – roll forward

procedures

8-11

Substantive Procedures

8-12 Copyright John Wiley & Sons Canada, Ltd.

Substantive Procedures

P la

n n

e d

Auditors will use various techniques

 INSPECTION of supporting documents

8-13

Substantive Procedures

CAIRORE

Direction of INSPECTION will determine what assertion is being tested

– Vouching

• Occurrence (Existence) – Tracing

• Completeness 8-14

Substantive Procedures

Direction of Tests for Sales

12- 15

C cradle to grave grave to cradle O

Substantive Procedures

How much of the balance should be examined?

Professional judgment • RMM

• Evidence available

• Sampling?

8-16

Substantive Procedures

Why do auditors perform analytical procedures?

• Audit planning

• Substantive testing

• Audit completion

8-17

Substantive Procedures

What are analytical procedures?

8-18

• Absolute data comparisons (prior year, budgets etc.)

• Ratio analysis (activity, liquidity, profitability, leverage)

• Trend analysis (over several accounting periods)

• Common-size financial statements • Break-even analysis • Pattern analysis and regression

(most sophisticated)

Substantive Procedures

Analytical procedures

• e.g., Rent expense

• Vouch twelve months of payments, or…?

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Substantive Procedures

Risk of OVERSTATEMENT or UNDERSTATEMENT?

Use of computers- CAATS • examine client files

• plan, perform evaluate

May depend on CR

8-20

Substantive Procedures

Analytical procedures • Primary (persuasive)

• Corroborative

• Minimal

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Substantive Procedures

• Evidence from different types of substantive procedures varies in persuasiveness

1. Persuasive evidence • Is suitable as primary test of balance

• Provides a reasonable estimate of balance, enabling auditor to conclude whether or not the account balance is free from material errors

• No further procedures required

Levels of Evidence

8-22

2. Corroborative

• Confirms audit findings from other procedures

• Supports management representations or otherwise decreases the level of audit skepticism

• Allows auditor to limit extent of other procedures in the area

• Unexpected results would require auditor to expand other substantive audit procedures to provide explanation of result

Levels of Evidence

8-24

3. Minimal

• Not persuasive or corroborative

• e.g., simple comparison with previous year to help identify problems, not to reduce other testing

– Usefulness of procedure to generate more persuasive evidence depends on circumstances such as complexity of client and extent of fluctuations in particular account balance

Levels of Evidence

8-26

Substantive Procedures

Misstatements?

– Errors (including fraud), vs

– Judgmental misstatements

– Isolated “one off” events, vs

– Systematic breakdowns

8-28