Podcast
Questions and Answers
Which audit process phase primarily focuses on performing tests and gathering evidence?
Which audit process phase primarily focuses on performing tests and gathering evidence?
- Phase I - Client acceptance
- Phase III - Testing and evidence (correct)
- Phase II - Planning
- Phase IV - Evaluation and Judgement
Substantive procedures are designed to detect material misstatements in the financial statements.
Substantive procedures are designed to detect material misstatements in the financial statements.
True (A)
Which of the following is an example of a test of details?
Which of the following is an example of a test of details?
- Analyzing gross profit margin trends
- Using regression models to predict revenue
- Vouching (correct)
- Comparing current year sales with prior year sales
What type of audit procedure involves analyzing financial trends and relationships instead of reviewing individual transactions?
What type of audit procedure involves analyzing financial trends and relationships instead of reviewing individual transactions?
Match the procedure with its correct definition:
Match the procedure with its correct definition:
What is the purpose of vouching in the context of auditing?
What is the purpose of vouching in the context of auditing?
Which assertion is tested when tracing shipping documents to sales invoices and entries in the sales ledger?
Which assertion is tested when tracing shipping documents to sales invoices and entries in the sales ledger?
An auditor is testing the accuracy of sales transactions. Which procedure would be most effective?
An auditor is testing the accuracy of sales transactions. Which procedure would be most effective?
If an auditor uses tracing as a substantive procedure on transactions, what is the auditor testing for?
If an auditor uses tracing as a substantive procedure on transactions, what is the auditor testing for?
Tracing is only used as a substantive procedure and not as a test of controls.
Tracing is only used as a substantive procedure and not as a test of controls.
Match whether 'Tracing' is a substantive procedure or a test of controls:
Match whether 'Tracing' is a substantive procedure or a test of controls:
What is the primary objective of physical verification of fixed assets?
What is the primary objective of physical verification of fixed assets?
An auditor is performing physical observation of inventory. What is the primary purpose of this procedure?
An auditor is performing physical observation of inventory. What is the primary purpose of this procedure?
If management is suspected of inflating revenue, what details beyond outstanding amounts should auditors confirm?
If management is suspected of inflating revenue, what details beyond outstanding amounts should auditors confirm?
When testing accounts receivable, vouching might be used for overstatements. What type of procedure is best for testing for understatement of accounts payable?
When testing accounts receivable, vouching might be used for overstatements. What type of procedure is best for testing for understatement of accounts payable?
To search for unrecorded liabilities, the auditor reviews ______ made by the client for a period after the balance sheet date.
To search for unrecorded liabilities, the auditor reviews ______ made by the client for a period after the balance sheet date.
Which type of confirmation provides more reliable audit evidence?
Which type of confirmation provides more reliable audit evidence?
Which of the following is a required alternative procedure if a response is not received for accounts receivable using the positive confirmation method?
Which of the following is a required alternative procedure if a response is not received for accounts receivable using the positive confirmation method?
If an audit client does not allow confirmations, it automatically indicates fraud risk.
If an audit client does not allow confirmations, it automatically indicates fraud risk.
What is the first step an auditor should take if a client restricts the use of confirmations?
What is the first step an auditor should take if a client restricts the use of confirmations?
Why should auditors prevent the client from influencing account selections for confirmation?
Why should auditors prevent the client from influencing account selections for confirmation?
Why is it important for the confirmation letter to include a request for the third party to respond directly to the auditor?
Why is it important for the confirmation letter to include a request for the third party to respond directly to the auditor?
What is one task the auditor performs in the monitoring process?
What is one task the auditor performs in the monitoring process?
What is a benefit of performing interim testing using substantive procedures?
What is a benefit of performing interim testing using substantive procedures?
How does the risk of material misstatement affect the extent of substantive procedures?
How does the risk of material misstatement affect the extent of substantive procedures?
Flashcards
Substantive Procedures
Substantive Procedures
Audit tests performed to detect material misstatements in the financial statements.
Tests of Details
Tests of Details
Examine underlying transactions and balances directly.
Substantive Analytical Procedures
Substantive Analytical Procedures
Analyzing financial trends instead of individual transactions.
Vouching
Vouching
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Tracing
Tracing
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Confirmation
Confirmation
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Recalculation
Recalculation
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Physical Verification
Physical Verification
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Occurrence
Occurrence
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Completeness
Completeness
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Classification
Classification
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Accuracy
Accuracy
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Cut-off
Cut-off
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Tracing
Tracing
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Search for Unrecorded Liabilities
Search for Unrecorded Liabilities
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Positive Confirmation
Positive Confirmation
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Negative Confirmation
Negative Confirmation
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Alternative Procedures For Accounts Receivable
Alternative Procedures For Accounts Receivable
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Alternative Procedures for Bank Confirmations
Alternative Procedures for Bank Confirmations
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Interim Testing
Interim Testing
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Substantive Procedures After Interim Testing
Substantive Procedures After Interim Testing
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Extent of Substantive Procedures
Extent of Substantive Procedures
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Study Notes
Audit Process Model
- Phase III involves both, testing and evidence
Substantive Procedures
- Used to detect material misstatements in financial statements
- Divided into two main types: tests of details and substantive analytical procedures
Tests of Details
- Directly examine underlying transactions and balances
Examples of Tests of Details
- Vouching
- Tracing
- Confirmation
- Recalculation
- Physical Verification
Substantive Analytical Procedures
- Analyzing financial trends and relationships rather than reviewing individual transactions
Examples of Analytical Procedures
- Comparing gross profit margin trends
- Analyzing sales growth vs. industry trends
- Using regression models to predict revenue
Assertions & Substantive Procedures on Sales
| Management Assertion | Audit Objective (Auditor's viewpoint) | Substantive Audit Procedures (Auditor's direct testing) |
|---|---|---|
| Occurrence | Ensure recorded sales actually occurred and are genuine. | Perform vouching by selecting a sample of sales transactions from the Sales Ledger and examining supporting documents (shipping documents, delivery notes, customer acknowledgments). Confirm selected transactions with customers if necessary. |
| Completeness | Ensure all sales that occurred are fully recorded. | Trace a sample of shipping documents (delivery notes) to recorded sales invoices and entries in the Sales Ledger and General Ledger. |
| Classification | Ensure sales are recorded in proper revenue accounts. | Examine a sample of recorded sales transactions to verify correct classification by comparing invoice details with revenue account descriptions. |
| Accuracy | Ensure sales amounts are recorded correctly at authorized prices and quantities. | Recalculate amounts on sample sales invoices, match prices to approved price lists, and quantities to customer purchase orders. |
| Cut-off | Ensure sales transactions are recorded in correct accounting period. | Review shipping documents and invoices around year-end; verify sales entries recorded in the correct accounting period (pre- and post-year-end cut-off). |
Tracing as a Dual Purpose Test
- Tracing is a technique to follow transactions from source documents to financial statements
- Tracing is used in both: substantive procedures (Tests of Details) and tests of controls
Tracing Aspect: Substantive Procedure vs Test of Controls
| Aspect | Tracing as a Substantive Procedure | Tracing as a Test of Controls |
|---|---|---|
| Purpose | Completeness of financial statement amounts. | Assess if internal controls over recording transactions are operating effectively. |
| Audit Focus | Ensuring valid transactions are recorded. | Evaluating if the control process ensures proper recording of transactions. |
| Direction | Bottom-up (Source documents → Ledger) | Bottom-up, but with assessing control implementation goal. |
| Example | Selecting shipping documents and tracing to sales invoices. | Testing an entity's control over sales invoices. |
| Assertion Tested | Completeness of transactions. | Control effectiveness in ensuring accurate and complete recording. |
Physical Inspection: Dual Purpose Test
| Aspect | Observation (Example: Inventory Count) | Physical Verification (Example: Checking Fixed Assets) |
|---|---|---|
| Definition | Watching a process being performed by the client. | Physically inspecting an asset to confirm its existence. |
| Who | Client's staff performs count, auditor observes. | Auditor directly inspects. |
| Audit Obj. | Effectiveness of the client's process (test of controls). | Asset physically exists (substantive procedure). |
| Assertion | Control effectiveness (is client following procedures). | Existence & Valuation (does asset exist and usability). |
| Auditor Action | Auditor watches employees count inventory at year-end ensuring procedures are followed. | Auditor checks machinery, inspecting its condition. |
Procedures to manage risks when inflating revenue to meet expectations:
- Auditor can design external confirmations to confirm outstanding amounts
- Confirm details of the sales agreements
- Inquire about changes in sales agreements and delivery terms
Account Balance Testing
- Each account balance is tested for over/understatement
Testing Over/Understatements
| Account | Primary Risk | Substantive Procedure | Direction of Testing |
|---|---|---|---|
| Assets (Cash, AR, Inventory) | Overstatement | Vouching (Ledger → Supporting Docs) | Top-Down |
| Liabilities (Loans, Payables) | Understatement | Tracing (Source Docs → Ledger) | Bottom-Up |
| Revenue (Sales, Interest) | Overstatement | Vouching (Ledger → Sales Invoices) | Top-Down |
| Expenses (COGS, Operating) | Understatement | Tracing (Purchase Orders → Ledger) | Bottom-Up |
Search for Unrecorded Liabilities
- Substantive test for accounts payable
- Test provides evidence as to completeness and valuation
- Auditor reviews disbursements, made after the balance sheet date
- Most unrecorded APs are typically paid within a reasonable time after the balance sheet date due to vendor pressure
Confirmation types: Positive vs Negative
| Aspect | Positive Confirmation | Negative Confirmation |
|---|---|---|
| Definition | Recipient responds, confirming balance correctness. | Recipient only responds if they disagree with the stated balance. |
| Relability | More reliable since response is required | Less reliable since no response is assumed to mean agreement. |
| Risk Level | Used when there is a higher risk of material misstatements or fraud. | Used when there is a lower risk and many small balances exist. |
| Evidance | Stronger audit evidence | Weaker audit evidence |
| Follow-Up | If no response, perform alternative procedures. | No follow-up required for non-responses. |
| example | "Please confirm if your balance of PKR 500,000 is correct or incorrect." | "If your balance of PKR 500,000 is incorrect, inform us." |
No Response to Confirmation Letter
- If no reply to positive confirmation, ISA requires alternative procedures
Accounts Receivable Alternative Procedures
- Checking subsequent cash receipts
- Examining shipping documents, invoices, & acknowledgments
Bank Confirmations Alternative Procedures
- Reviewing bank statements and reconciliations
- Non-response doesn't mean the balance is accurate, alternative testing is needed.
Audit Client Does Not Allow Confirmations
- Management's refusal is a red flag
- Inquire why confirmations are restricted
- Assess reason validity
- Perform alternative procedures to verify balances OR
- Consider scope limitation leading to qualified opinion/disclaimer
- Management unreasonably restricting confirmations may indicate fraud risk
Sending Confirmation Letters: Steps
- Select accounts for confirmation based on audit risk and materiality, prioritizing high-risk accounts.
- Auditor should not allow client to influence the selection.
- Prepare confirmation letter using client's letterhead, addressed to third parties, including specific balance or details and a request for response directly to the auditor.
- Client's approval and Authorization are needed. The client must not mail the letters or handle responses.
- Mail or electronically send confirmations yourself; client should not be involved in mailing.
- Use client's envelope with their letterhead; send letters directly and include a self-addressed return envelope (auditor's address).
- The client should not send or collect the responses.
- Monitor responses and follow up on non-replies; if no response, send follow-up requests and perform alternative audit procedures
Evaluate Responses and Identify Discrepancies
- Look for discrepancies between confirmed balances, unusual terms, misstatements or fraud indicators
- Significant differences require further investigation
- Do not Ignore discrepancies without further verification
Interim Testing Using Substantive Procedures
- Performing these at an interim date aids in identifying and resolving issues early in the audit.
- Stage increases risk of undetected misstatements.
- Cover remaining period by performing substantive procedures from interim to the period end.
Extent of Substantive Procedures
- Greater risk of material misstatement = greater extent of substantive procedure, this can lower DR to an acceptable level.
- The extent of testing depends on sample size affected by the risk of material misstatement
- Automated tools enable more extensive testing of electronic transactions
- Substantive procedures may be reduced if internal controls are adequate
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