Performing Substantive Tests

Chapter 8
Substantive Tests
• Substantive tests are audit procedures designed to substantiate the
account balances or to detect material misstatements in the financial
statements.
• Analytical procedures
• Test of details
Analytical Procedures
• Analytical procedures applied as substantive tests enable the auditor to
obtain corroborative evidence about a particular account. This
approach involves comparison of financial information with auditor’s
expectations to determine the reasonableness of an account balance
reported in a financial statement.
Test of Details
• Test of details involves examining the actual details making up the
various account balances. This approach may take the form of test of
details of balances or test of details of transactions.
• Test of details of balances involves direct testing of the ending balance
of an account.
• Test of details of transactions involves testing the transactions which
give rise to the ending balance of an account.
Effectiveness of Substantive Tests
• Nature of substantive test
• Timing of substantive test
• Extent of substantive test
Relationship Between Substantive Test and
Test of Control
• Tests of controls provide evidence that indicates a misstatement is
likely to occur. Substantive tests, on the other hand, provide evidence
about the existence of misstatement in an account balance.
Audit Evidence
• Evidence refers to the information obtained by the auditor in arriving
at the conclusions on which the audit opinion is based.
• Underlying accounting data refers to the accounting records
underlying the financial statements.
• Corroborating information supporting the underlying accounting data
obtained from client and other sources.
Qualities of Evidence
• Sufficiency refers to the amount of evidence that the auditor should
accumulate.
• Competence
• Materiality
• Risk
• Experience
• Appropriateness is the measure of the quality of audit evidence and its
relevance to a particular assertion and its reliability.
• Relevance relates the timeliness of evidence and its ability to satisfy
the audit objective.
• Reliability relates to the objectivity of evidence and is influenced by
its source and by its nature.
• Independent outside sources
• Accounting and internal control systems
• Obtained directly by the auditor
• Documents and written representations
Cost/Benefit Consideration when Obtaining
Evidence
• There should be a rational relationship between the cost of obtaining
evidence and the usefulness of the information obtained. The auditor
uses his professional judgment in determining the appropriate type of
evidence that should be obtained.
Audit Documentation/Working Papers
• Working papers are records kept by the auditor that documents the
audit procedures applied, information obtained and conclusions
reached.
Functions of the Working Papers
• Support the auditor’s opinion on financial statements.
• Support the auditor’s representation as to compliance with PSA.
• Assist the auditor in the planning, performance, review and
supervision of the engagement.
• Assist the auditor in planning future audits.
• Providing information useful in rendering other services.
• Providing adequate defense in case of litigation.
Form, Content and Extent of Audit
Documentation
• The nature of the audit procedures to be performed;
• The identified risks of material misstatement;
• The extent of judgment required in performing the work and evaluating the
results;
• The significance of the audit evidence obtained;
• The nature and extent of exceptions identified;
• The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit
evidence obtained; and
• The audit methodology and tools used.
Classification of Working Papers
• Permanent file contains information of continuing significance to the
auditor in performing recurring audits.
• Current file contains evidence gathered and conclusions reached
relevant to the audit of a particular year.
Ownership of Working Papers
• Working papers are the property of the auditor and the client has no
right to the working papers prepared by the auditor. Working papers
may sometimes serve as a reference source for the client but they
should not be considered as part or as a substitute for the client’s
records.
Confidentiality of Working Papers
• When disclosure is required by law or when the working papers are
subpoenaed by a court.
• When there is a professional right to disclose information such as
when the auditor uses his working papers to defend himself when sued
by the client for negligence.
Retention of Working Papers
• Working papers should be retained by the auditor for a period of time
sufficient to meet the needs of his practice and to satisfy any pertinent
legal requirements of record retention.
Guidelines for the Preparation of Working
Papers
• Heading
• Indexing
• Cross-indexing/Cross referencing
• Tick marks
Auditing Accounting Estimates
• Accounting estimate means an approximation of the amounts of an
item in the absence of a precise means of measurement. Accounting
estimates are often made in conditions of uncertainty regarding the
outcome of events that have occurred or are likely to occur and
involve the use of judgment.
Auditor’s Responsibility
• Review and test the process used by management to develop the
estimate.
• Make an independent estimate.
• Review subsequent events which confirm the estimate made.
Related Parties
• Generally accepted accounting principles in the Philippines require
disclosure in the financial statements of certain related party
relationships and transactions.
• A related party transaction may be motivated by other than ordinary
business considerations such as profit sharing or even fraud.
• The existence of related parties or related party transactions may affect
the financial statements and the reliability of audit evidence.
Management’s Responsibility
• Management is responsible for the identification and disclosure of
related parties and transactions with such parties. This responsibility
requires management to implement adequate accounting and internal
control systems to ensure that transactions with related parties are
appropriately identified in the accounting records and disclosed in the
financial statements.
Auditor’s Responsibility
• The auditor should obtain and review information provided by the
directors and management identifying the names of all known related
parties and related party transactions.
Using the Work of an Auditor’s Expert
• Auditor’s Expert
• An expert, whose work in his field of specialization, is used by the auditor to
assist the auditor in obtaining sufficient appropriate audit evidence.
• Management’s Expert
• An expert, whose work in his field of expertise, is used by the entity to assist
the entity in preparing the financial statements.
Determining the Need for an Auditor’s Expert
• Whether management has used a management’s expert in preparing
the financial statements.
• The nature and significance of the matter, including its complexity.
• The risks of material misstatement in the matter.
• The expected nature of procedures to respond to identified risks,
including the auditor’s knowledge of an experience with the work of
experts in relation to such matters; and the availability of alternative
sources of audit evidence.
Evaluating the Auditor’s Expert
• Assess the competence and objectivity of the expert.
• Understand the field of the expertise of auditor’s expert.
• Establish the terms of the agreement with the expert.
• Evaluate the results of the work of the expert.
Effect of the Reliance on Expert’s Work on
the Audit Report
• The auditor has sole responsibility for the audit opinion expressed, and
that responsibility is not reduced by the auditor’s use of the work of an
expert. Thus, the auditor should not refer to the work of an auditor’s
expert in an auditor’s report containing an unmodified opinion.
Considering the Work of Internal Auditors
• Internal auditing is an appraisal activity established within an entry as
a service to the entity. The external auditor should obtain a sufficient
understanding of the internal audit activities to assist in planning the
audit and developing an effective audit approach. An effective internal
auditing will often affect the nature timing and extent of the external
auditor’s procedures.
Preliminary Assessment of Internal Auditing
• Competence
• Objectivity
• Due professional care
• Scope of function
Evaluating and Testing the Work of Internal
Auditors
• If based on the foregoing assessment, the external auditor decides to
use the work of the internal auditor, the external auditor will have to
evaluate and test the internal auditor’s work to confirm its adequacy
for the external auditor’s purposes. This evaluation may include
considering whether the work is performed by competent persons;
sufficient appropriate evidence is obtained; appropriate conclusions
are reached; and exceptions are properly resolved.