1. Prepared by: Angela Davis CA, CFE, MSc Booth University College
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2. SUBSTANTIVE TESTING AND BALANCE SHEET ACCOUNTS
Explain the relationship between the overall risk assessment for a significant account and the extent and timing of substantive procedures
Design and understand how to execute substantive procedures to address audit risk related to cash
Design and understand how to execute substantive procedures to address audit risk related to trade receivables
Design and understand how to execute substantive procedures to address audit risk related to inventory
Design and understand how to execute substantive procedures to address audit risk related to property, plant, and equipment
Design and understand how to execute substantive procedures to address audit risk related to payables
Understand how substantive testing is used for other balance sheet accounts
Understand how to assess the results of substantive procedures to determine whether additional substantive tests are necessary
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3. Risk and substantive procedures
Extent of substantive procedures
Determined by risk assessment
Trivial or immaterial accounts are either ignored or subjected to analytical procedures only
Audit risk model used to make a risk assessment on each significant account or disclosure
High IR, CR: do not rely on and test controls, use significant amount of substantive testing to reduce DR to acceptable level
Low IR, CR: testing controls shows them to be effective, limited substantive testing required
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4. Risk and substantive procedures cont’d
2. Timing of substantive procedures
Also determined by risk assessment
Lower DR, more work done at year-end
Audit firm must also consider availability of resources to conduct procedures around year-end
Use techniques to influence schedule:
Review events prior to year-end, e.g. acquisitions
Review activity in period to date, e.g. review interim ageing of trade receivables then update at year-end
Perform general audit procedures prior to year-end, e.g. read board minutes
Review provisions prior to year-end, e.g. understand estimation processes used by management
Leverage off internal audit (CAS 610)
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5. Risk and substantive procedures cont’d
Figure 10.2
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6. Risk and substantive procedures cont’d
3. Other matters to consider in designing substantive procedures
Ensure procedures respond to specific risk faced by client from both IR and CR factors
Different clients may have same overall level of risk but risk caused by different factors – procedures would be also different
Take credit for work already done – early work in audit to assess risk also provides evidence
Set appropriate testing thresholds – what does auditor consider important for this audit?
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7. Substantive testing – Cash
Most important assertions: existence, completeness, classification
Existence
Usually addressed by bank confirmation (CAS 505)
Completeness
Test bank reconciliation and cut-off of cash transactions
Verify reconciling items to next period bank statement
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8. Substantive testing – Cash cont’d
Classification
Important because of special disclosure requirements
Rights and obligations assertion also significant where clients may pledge assets
Pledging restricts client’s rights over cash
Valuation and allocation usually only an issue when client has significant foreign currency bank accounts
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9. Substantive testing – Cash cont’d
Table 10.1
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10. Substantive testing – Cash cont’d
Processes impacting on the audit of cash
Auditor assesses evidence obtained from interim testing on significant transactions, control testing
When CR low, unlikely to do additional testing on cash receipts and payments, focus on balance
If CR not low, substantive tests of receipts and payments may be required
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11. Substantive testing – Cash cont’d
Table 10.2
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12. Substantive testing – Cash cont’d
Table 10.2 (continued)

13. Substantive testing – Cash cont’d
Testing cash account balances always done at some level, additional procedures required as risk assessment increases
Tests include bank confirmations, bank reconciliation re-performance, analytical procedures etc
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14. Substantive testing – Cash cont’d
Table 10.3
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15. Substantive testing – Trade Receivables
Most important assertions: existence, valuation & allocation
Existence
Usually addressed by confirmation (CAS 505)
Positive confirmation: auditor requests reply in all circumstances
Negative confirmation: auditor requests reply only if debtor disagrees with balance shown
Confirmations do not provide assurance about valuation because they do not address recoverability
Examine receipts of cash by client after year end to assess valuation at balance date
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16. Debtor’s confirmation

17. Substantive testing – Receivables cont’d
Valuation & Allocation
Use subsequent receipts test
Analytical procedures based on ageing
Classification assertion can also be important because of disclosures, such as related parties and financial instruments
Rights & obligations can also be important because of restrictions on trade terms
Completeness can be addressed through cut-off testing
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18. Substantive testing – Receivables cont’d
Table 10.4
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19. Substantive testing – Receivables cont’d
Processes impacting on trade receivables
Most important transactions impacting the balance of receivable are sales, sales returns and allowances, cash receipts
Usually, auditor relies on control testing of these transactions to confirm low CR
If CR not low, substantive tests required for the transactions
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20. Substantive testing – Receivables cont’d
Table 10.5
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21. Substantive testing – Receivables cont’d
Table 10.5 (continued)
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22. Substantive testing – Receivables cont’d
Table 10.5 (continued)
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23. Substantive testing – Receivables cont’d
Table 10.5 (continued)
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24. Substantive testing – Receivables cont’d
Table 10.6
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25. Substantive testing – Receivables cont’d
Table 10.6 (continued)
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26. Substantive testing – Inventory
Most important assertions: existence, valuation & allocation
Existence
Usually addressed by testing client’s annual or cyclical inventory count (CAS 501)
Auditor tests client’s verification of physical inventory with records, and auditor must sight inventory
If controls not strong or if physically difficult to count inventory often the inventory count is performed annually
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27. Substantive testing – Inventory cont’d
Valuation & allocation
Important inventory recorded at the appropriate carrying value
Viewing inventory at the inventory count allows auditor to assess slow-moving, damaged, obsolete, impaired, excess inventory which should be written down
Typical techniques:
Vouching to invoices to verify initial cost
Vouching to sales details to verify cost of sales
Test provision for impairment calculations
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28. Substantive testing – Inventory cont’d
Completeness not usually a major issue, but risk of understatement can be issue where goods sold on consignment
Rights & obligations also relevant for some clients due to consignment sales, complex purchasing contracts
Classification usually addressed by testing inventory listing, allowing verification of disclosures
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29. Substantive testing – Inventory cont’d
Table 10.7
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30. Substantive testing – Inventory cont’d
Processes impacting inventory
Purchasing, cash payments, and inventory records
Usually, auditor relies on control testing of these transactions to confirm low CR
If CR not low, substantive tests required for the transactions
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31. Substantive testing – Inventory cont’d
Table 10.8
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32. Substantive testing – Inventory cont’d
Table 10.8 (continued)
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33. Substantive testing – Inventory cont’d
Table 10.8 (continued)
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34. Substantive testing – Inventory cont’d
Table 10.8 (continued)
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35. Substantive testing – Inventory cont’d
Table 10.8 (continued)
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36. Substantive testing – Inventory cont’d
Table 10.9
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37. Substantive testing – Inventory cont’d
Table 10.9 (continued)
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38. Substantive testing – Inventory cont’d
Table 10.9 (continued)
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39. Substantive testing – PPE
Most important assertions: existence, valuation & allocation
Existence
Verify items recorded in client’s fixed asset register
Physically sight assets listed in first audit and periodically for subsequent audits
Focus on additions and disposals in later years
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40. Substantive testing – PPE cont’d
Valuation & allocation
Evidence about condition gathered when sighting physical assets
Consider appropriate cost, carrying value or fair value (IAS 16), and asset impairment
Change in client operations could impact fair values
Vouch initial cost to invoices, contracts
Vouch disposals to sales contracts, receipts
Test depreciation through reasonableness testing of depreciation charge compared to cost base and useful life of the asset
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41. Substantive testing – PPE cont’d
Completeness not usually major issue
Rights and obligations – tested during initial audit then test periodically depending on type of assets in the register
Tests include verifying
Registered titles, registration papers, invoices
Lease agreements
Classification - generally addressed by testing fixed asset register
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42. Substantive testing – PPE cont’d
Table 10.10
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43. Substantive testing – PPE cont’d
Processes impacting PPE
Cash receipts, cash payments, purchasing
Substantive testing when CR high
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44. Substantive testing – PPE cont’d
Table 10.11
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45. Substantive testing – PPE cont’d
Table (continued)
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46. Substantive testing – PPE cont’d
Table 10.12
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47. Substantive testing - Payables
Most important assertions are completeness and valuation & allocation
Major risk is understatement
Use subsequent payments testing
Vouch payments after balance date to invoices to verify invoices dated prior to year-end are included in payables
Cut-off testing
Select sample of purchases either side of year-end and verify that each included or excluded from payables based on invoice date
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48. Substantive testing – Payables cont’d
Existence and rights & obligations not usually important because they relate more to risk of overstatement
Classification important if there are related party transactions, lease commitments or other forms of finance included in the payables balance
Accruals are treated in same way as payables, search for unrecorded amounts through subsequent payments testing
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49. Substantive testing – Payables cont’d
Table 10.13
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50. Substantive testing – Payables cont’d
Table 10.14
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51. Substantive testing – Payables cont’d
Table (continued)
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52. Substantive testing – Payables cont’d
Table 10.15
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53. Substantive testing – Other
Most other accounts are typically audited substantively because they do not rely on high volume processes and specific application controls
Auditor’s objective is to identify and quantify any errors
Understand why error occurred
Assess need for additional testing
Make final estimate of misstatement, assess materiality
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