2. Chapter 9 Substantive Procedures and the Financial Statement Audit Prepared by Richard J. Campbell Copyright 2011, Wiley and Sons

3. Learning Objectives 1. Recognize the audit associations of transaction cycles, account balances, management assertions, and audit steps. 2. Understand the reasons an audit opinion is limited to reasonable assurance. 3. Learn to draw conclusions from the results of audit tests of account balances. 4. Understand the audit documentation appropriate for substantive tests and procedures. Chapter 9 -1

4. Learning Objectives 5. Become familiar with specific topics that are particularly important to financial statement audits, for example, estimation processes, going-concern considerations, and period-end cutoff. 6. Learn the substantive tests and procedures that are important for the various financial statement accounts. Chapter 9 -2

5. TRANSACTION CYCLES AND ACCOUNT BALANCES Learning Objective #1Chapter 9 -3  Transaction cycles can be defined differently for different businesses and industries, but generally most businesses have a cycle dealing with Sales or sources of revenue and cash receipts Purchases or acquisitions and cash disbursements Human resources Production or inventory, which, when necessary includes cost accounting Activities that are financing related, such as investment, debt, and equity transactions

6. Substantive Procedures on Accounts and Disclosures Chapter 9 -4Learning Objective #1 EXHIBIT 9-1

7. MATERIALITY AND REASONABLE ASSURANCE Chapter 9 -5Learning Objective #2  Sampling is used for tests of details of balances  Errors in audit tests and procedures are either nonsampling or sampling errors  Sampling error can also occur on an audit when the selected sample does not represent the population

8. MATERIALITY AND REASONABLE ASSURANCE Chapter 9 -6Learning Objective #2

9. Analytical Procedures, Fluctuation Analysis Learning Objective #2Chapter 9-7 EXHIBIT 9-2

10. Audit Risk Model Chapter 9 -8Learning Objective #2 AR stands for audit risk RMM is the risk of material financial statement misstatement IR stands for inherent risk CR stands for control risk DR stands for detection risk. TD is the risk that a material misstatement will be missed by the auditor’s tests of details of balances. AP is the risk that a material misstatement is missed by the audit’s analytical procedures

11. PERFORMING SUBSTANTIVE TESTS AND PROCEDURES Chapter 9 -9Learning Objective #2  Auditors perform substantive tests using tests of details of balances and substantive analytical procedures  A general description of the initial steps for a test of details of balances using a sample is as follows: 1. Determine which account and assertion is being evaluated 2. Decide what audit procedure needs to be used to test the assertion 3. Decide on the sampling method. 4. Decide on the sampling frame, or physical population from which the sample is selected, and the sampling unit.

12. PERFORMING SUBSTANTIVE TESTS AND PROCEDURES (Part 2) Chapter 9 -10Learning Objective #2 5. Determine the method to select the sample, such as utilizing identifying numbers produced by a random number generator, systematic sampling with a random start, or haphazard sampling. 6. Determine the sample size needed. 7. Select the sample, perform the test, and identify discrepancies 8. Evaluate the sample results.

13. Conclusions as a Result of Substantive Tests and Procedures: Evaluating Results Steps to evaluate an account balance based on an audit test of a sample are summarized as follows: 1. Determine the recorded amount of the sample. 2. Using evidence collected from the sample, investigate the misstatements. 3. Using the sample as a basis, estimate the “true” account balance. 4. Set a tolerable misstatement 5. Evaluate whether the account balance is materially misstated and requires an adjustment 6. Consider the impact of the audit findings on other accounts, fraud risk, and ICFR. Learning Objective #3Chapter 9 - 11

14. Quantitative Evaluation of Sample Results Learning Objective #3Chapter 9-12 EXHIBIT 9-3

15. Quantitative Evaluation of Fishtrackers’ Inn Outcome Learning Objective #3 Chapter 9-13 EXHIBIT 9-4

16. Quantitative Evaluation of Fishtrackers’ Inn Outcome Learning Objective #3 Chapter 9-14 EXHIBIT 9-4

17. AUDIT DOCUMENTATION Learning Objective #4 Chapter 9-15  Lead schedule is the term for the audit work paper that lists and specifies the components that make up the line item on the working trial balance.  Detailed work papers support the information on the lead schedule, providing information about the audit tests performed on each component of the trial balance line item and results of the tests.

18. Work Paper Examples Learning Objective #4 Chapter 9-16 EXHIBIT 9-5

19. Work Paper Examples Learning Objective #4 Chapter 9-17

20. IMPORTANT CONSIDERATIONS IN A FINANCIAL STATEMENT AUDIT Learning Objective #5 Chapter 9-18 Estimates

21. Fair Value Measurements and Disclosures Learning Objective #5 Chapter 9-19

22. Illegal Acts Learning Objective #5 Chapter 9-20

23. Related Party Transactions Learning Objective #5 Chapter 9-21

24. Going Concern Learning Objective #5Chapter 9-22

25. AREAS ADDRESSED IN A FINANCIAL STATEMENT AUDIT Learning Objective #6Chapter 9-23 Examples of Audit Steps for Cash EXHIBIT 9-6

26. AREAS ADDRESSED IN A FINANCIAL STATEMENT AUDIT Learning Objective #6Chapter 9-24

27. Receivables Learning Objective #6Chapter 9-25

28. Receivables Learning Objective #6Chapter 9-26

29. Inventory Learning Objective #6 Chapter 9-27

30. Inventory Learning Objective #6 Chapter 9-28

31. Investments, Emphasis on Marketable Securities Learning Objective #6 Chapter 9-29 EXHIBIT 9-9

32. Investments, Emphasis on Marketable Securities Learning Objective #6 Chapter 9-30

33. Current Payables Learning Objective #6 Chapter 9-31 Examples of Audit Steps for Accounts Payable EXHIBIT 9-10

34. Long-Term Debt Learning Objective #6 Chapter 9-32 Examples of Audit Steps for Long- Term Debt EXHIBIT 9-11

35. Long-Term Debt Learning Objective #6 Chapter 9-33

36. SUMMARY OF SUBSTANTIVE TESTS AND PROCEDURES Learning Objective #6 Chapter 9-34

37. APPENDIX A: STATISTICAL TECHNIQUES AND TESTS OF DETAILS OF BALANCES Appendix A Chapter 9-35 Characteristics and Sample Size EXHIBIT A9-1

38. APPENDIX A: STATISTICAL TECHNIQUES AND TESTS OF DETAILS OF BALANCES Chapter 9-36 Confidence Coefficients EXHIBIT A9-2 Appendix A

39. APPENDIX A: STATISTICAL TECHNIQUES AND TESTS OF DETAILS OF BALANCES Learning Objective #3 Chapter 9-37 Results of the Sample and Audit Analysis EXHIBIT A9-3

40. Review Question Chapter 9-38 Which of the following audit processes will the auditor have to wait until the end of the fiscal year, or after, to perform? (a) Observing the inventory count (b) Testing the operating effectiveness of the yearend closing and reporting process (c) Inquiring of the client and identifying related parties (d) Evaluating the possibility of illegal acts

41. Review Question Chapter 9-39 Regarding illegal acts, which of the following is not true? (a) The auditor is more likely to become aware of illegal acts that have a direct impact on the financial statements. (b) The auditor does not have to follow up on material illegal acts that he or she becomes aware of as long as they do not have a direct effect on the financial statements. (c) Illegal acts are one of the topics that is covered in the management representations letter. (d) All of the above are true.

42. Review Question Chapter 9-40 Which of the following is not important to the auditor regarding related party transactions? (a) Adequacy of disclosure of material related party transactions (b) Material misstatement of any of the transactions because they are not arms length (c) Identifying all the related parties so that the related party transactions and financial statement disclosure can be evaluated (d) All of these are important to auditing related party transactions.

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