1. Substantive tests of transactions and balances
Chapter 10
Substantive tests of transactions and balances
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

2. Learning objective 1: Relationship between evidence-gathering procedures
Auditor has to obtain sufficient appropriate evidence to support the audit opinion.
Tests of controls (Ch 9) and substantive tests of transactions and balances are the main evidence-gathering audit procedures.
Auditor selects the most efficient and effective combination of audit procedures that allows them to achieve audit objective.
Assertions are used to help them in their risk assessment of material misstatement, and to direct their audit procedures in responding to these risks.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

3. Relationship between tests of controls and substantive tests of transactions
Most controls are built around transaction flows.
Tests of controls: transactions selected to test whether related controls are working. Does not directly measure monetary error in accounting records.
Substantive test of transactions: transactions selected to determine whether monetary errors have occurred.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

4. Dual purpose tests
These are tests of transactions that address both control and substantive matters simultaneously.
Very common in practice since both tests of controls and substantive tests of transactions commonly involve inspection of documents.
It is efficient to perform tests of control and substantive tests on transactions selected simultaneously, e.g. select document and check evidence of authorisation (test of control) and recompute amount (substantive test of transaction).
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

5. Relationship between substantive tests of transactions and balances
Objective of substantive tests is to reduce detection risk to an acceptable level.
Substantive tests of transactions focus on the individual transactions that make up the balance.
Substantive tests of balances substantiate the ending balance of an account (which is comprised of multiple transactions).
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

6. Distinguishing between substantive tests of transactions and substantive tests of balances
The $5000 balance for Able could be verified by confirming this balance with customer (substantive test of balances) or verifying to supporting documentation the three transactions comprising this balance (substantive tests of transactions).
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

7. Learning objective 2: Financial report assertions and substantive audit procedures
The auditor develops specific audit procedures to evaluate and address the risk of material misstatement for both classes of transactions and events, and account balances.
The risk associated with each assertion is assessed, and substantive audit procedures are directed at specific assertions based on this assessment.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

8. Assertions about transactions and events
Occurrence: in testing whether transactions that generated financial report accounts actually occurred.
Completeness: the auditor identifies evidence indicating items that should be included in the class of transactions and investigates whether they are, in fact, included.
Accuracy: relates to determining the appropriate recording of the dollar value and other information of transactions.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

9. Assertions about transactions and events (cont.)
Cutoff: involves checking that transactions are recorded in the correct period.
Classification: in designing substantive tests for the assertion of classification, the auditor considers the appropriate classification of the item in the financial report.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

10. Assertions about account balances
Existence: the auditor selects from items contained in the accounting records and obtains evidence that supports them.
Rights and obligations: the auditor must ascertain that the assets are owned/controlled by the client and that the liabilities are those of the client.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

11. Assertions about account balances (cont.)
Completeness: the auditor identifies evidence indicating items that should be included in the account balance and investigates whether they are in fact included.
Valuation and allocation: the auditor considers the appropriateness of the basis of valuation of the asset or liability and the basis of any allocation of this valuation across accounting periods.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

12. Existence/occurrence and completeness assertions
Note that the direction of testing determines whether existence/occurrence or completeness assertion is tested.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

13. Cash receipts/payments
Learning objective 3: Cash, cash receipts and cash payments: assertions of interest
These are primarily:
Cash
Cash receipts/payments
Existence;
Completeness; and possibly
Valuation and allocation (if foreign currency balances).
Occurrence
Accuracy (if foreign currency transactions).
— since these are areas where misstatements are most likely to occur.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

14. Approach in auditing cash balances
Determined by assessing level of control risk in bank and cash handling procedures.
Much of this information will come from evaluations and tests of controls in the sales and cash receipts system, and the purchases and cash payments system.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

15. Assertions, objectives and procedures for cash receipts and payments
(cont.)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

16. Assertions, objectives and procedures for cash
Table 10.1 (cont.)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

17. Cash: key procedures These are:
Obtaining confirmation of bank balances from client’s bankers
Testing of client’s bank reconciliation.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

18. Learning objective 4: Sales, cash receipts and accounts receivable
Occurrence
Accuracy
Existence
Valuation and allocation
Assertions of interest
— as these are areas in which misstatements are most likely to occur
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

19. Accounts receivable: key audit procedures
Confirmation
Subsequent receipts review
Cutoff
Analytical procedures
Tests of sales transactions
Review of aged trial balance
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

20. Assertions, objectives and procedures for sales
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

21. Assertions, objectives and procedures for accounts receivable
Table 10.2 Assertions, objectives and substantive procedures for accounts receivable (p. 465)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

22. Accounts receivable confirmation and other procedures
Auditor may obtain confirmation from debtors using:
Positive form — once debtor has been selected, auditor must obtain evidence and asks client to respond, whether or not they agree with information as to amount owed in request. There will be follow-up procedures such as second request, checking invoices to shipping documents to prove sale for any non-response.
Negative form — requests client to respond when they disagree with amount shown.
Auditor should also consider other procedures such as examining evidence of subsequent cash receipts, and examining sales and shipping documents.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

23. Format of positive accounts receivable confirmation requests
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

24. Confirmation procedure versus subsequent cash receipts testing
Subsequent cash receipts testing is commonly viewed as a superior form of evidence compared with confirmation procedures because it achieves both key assertions.
Confirmation
Subsequent cash receipts testing
Existence YES
Valuation and NO
allocation
Existence YES
Valuation and YES
Confirmation still requires further tests of likelihood of payment (doubtful debts provision), which is part of valuation and allocation.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

25. Learning objective 5: Purchases and inventory
Inventory consists of goods to be sold or used in the production of saleable goods.
Major transactions involving inventory: increase to inventory when goods purchased and decrease to inventory when goods sold.
Inventory is generally considered high risk because it:
Is significant to determination of income
Involves a high volume of activity
Involves accounting complexities
Is susceptible to manipulation.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

26. Inventory: assertions of interest
Two key assertions of inventory are generally:
Existence
Valuation and allocation.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

27. Inventory: key procedures
Observation of physical inventories
Analytical procedures
Cutoff
Tests of pricing and summarisation
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

28. Assertions, objectives and procedures for purchases
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

29. Assertions, objectives and procedures for inventory
Table 10.3 Assertions, objectives and substantive procedures for inventory (p. 473)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

30. Inventory: observation of physical inventory — stocktake
Where inventory is considered material, auditor should attend a physical inventory count (stocktake), unless impractical.
When attending stocktake, auditor uses a combination of observation, inquiry and making test counts.
If inventory is outside auditor’s area of expertise, he/she should consider utilising services of expert.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

31. Inventory: tests of pricing and summarisation of count procedures
The auditor uses a combination of vouching, tracing and recomputation evidence-gathering procedures. In performing these procedures the auditor’s main concerns are:
Identifying obsolete, excess and slow-moving items
That inventory is counted correctly and that the results of inventory count are updated correctly
That prices for goods are applied appropriately
That inventory is appropriately valued at the lower of the cost and net realisable value
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

32. Learning objective 6: Accounts payable and payments
A primary assertion of concern is completeness, as the most likely form of misstatement is understatement.
Confirmation is a common audit procedure that addresses this assertion.
A search for unrecorded liabilities and analytical procedures performed on related expense account balances are also common procedures for completeness.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

33. Assertions, objectives and procedures for purchases
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

34. Table 10.4 (cont.)
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

35. Assertions, objectives and procedures for accounts payable
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

36. Learning objective 7: Non-current assets
The balances of non-current asset accounts are usually affected by a few relatively large transactions each year.
For this reason, it is usually efficient for auditors to verify account balances by performing tests on individual transactions.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

37. Property, plant and equipment
Assertions of interest are generally:
Existence
Rights and obligations
Valuation and allocation.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

38. Property, plant and equipment: key procedures
Substantiating additions and identifying retirements
Considering any revaluations
Analytically testing and recomputing related expense accounts such as depreciation
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

39. Assertions, objectives and procedures for property, plant and equipment
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

40. Investments and intangible assets
Assertions generally of interest are:
Rights and obligations
Existence
Valuation and allocation.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

41. Assertions, objectives and procedures for investments
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

42. Intangibles — use of experts
Assertions in relation to existence, valuation and allocation for intangible assets are particularly subjective given the nature of intangible assets.
Auditor may consider the use of experts where issues are outside of auditor’s own expertise.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

43. Investments and intangibles: key procedures
Physical examination
Confirmation
Inspection of legal documents
Recomputation, vouching, tracing
Specialised valuation procedures
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

44. Learning objective 8: Non-current liabilities and owners’ equity: key procedures
Key assertion:
Completeness
Key procedures:
Confirmation
Reading minutes of meetings
Examination of contracts and agreements
Inspection of share registers.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

45. Assertions, objectives and procedures: non-current liabilities
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

46. Learning objective 9: Income statement accounts: assertions of interest
In a double-entry accounting system, testing one side of a transactions automatically tests the other side.
A procedure that achieves an audit objective for one side of a transaction should achieve a comparable audit objective for the other side.
For example, if the auditor verifies the existence of an accounts receivable balance, this will verify the occurrence of the related sales transactions.
For this reason the extent of substantive tests of transactions is negatively related to the amount of substantive testing of balances that is undertaken.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

47. Audit procedures for income statement accounts
Substantiation indirectly by simultaneous tests of accounts, e.g. sales  accounts receivable
Substantiation directly in conjunction with balance sheet accounts, e.g. plant & equipment  depreciation
Substantiation directly by analytical procedures, e.g. relationships following a predictable pattern such as sales  sales commission
Substantiation directly by separate tests of individually significant transactions, events or account balances, e.g. discontinued operations
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

48. Learning objective 10: Auditing by computer: testing clients’ files
The major way the auditor uses the computer for substantive tests involves using audit software to read clients’ master files and/or transactions files.
Major advantages:
Directs auditor’s attention to items of risk and/or materiality
Undertakes routine audit tasks efficiently.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

49. Functions of audit software
This software can interrogate clients’ files in order to:
Select sample items
Identify records meeting specified criteria (exception reporting)
Test and make calculations
Compare data in separate fields or on separate files
Summarise data
Write reports.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett

50. Auditing by computer: four major techniques
Generalised audit software: audit interrogation software used with many clients
Specialised audit software: audit interrogation software especially written for client, task or industry
Utility programs: software or hardware designed to accomplish common routine tasks e.g. sort, merge
Systems management programs: enhanced productivity tools (e.g. data retrieval software) typically part of sophisticated operating systems environments.
Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Auditing and Assurance Services in Australia 3r by Grant Gay and Roger Simnett
Slides prepared by Roger Simnett