For example, you are an auditor and your senior gives you the revenue cycle for testing. And you will have some questions about what should you do in control testing and what should you do in substantive testing. The testing will be different from the balance sheet items and income statement items. Normally, if both of these items are correct, then the items in the statement of change in equity, and statement of cash flow are also correct.
An audit is to give an opinion on the financial statements or information. Accounts receivable and Accounts payable GLs can be tested by verifying the receipts or payments after the period end. Refer to AP article for understanding the subsequent payments testing procedure. Auditors perform audit procedures to collect sufficient and appropriate audit evidence. The extent and scope of procedures vary from client to client and period to period. These procedures are performed at different levels including planning, execution, and opinion formation.
Similar to Chapter 12 – Designing Substantive Procedures (
The auditor obtains this audit evidence by using compliance and substantive procedures. Vouching of business transactions and verification of assets and liabilities also form part of substantive procedures.
What is the difference between test of controls and substantive procedures?
In simple terms, control tests involve checking that a client's control is working, whereas a substantive test involves ignoring client systems and just checking the numbers. An example: Companies try to ensure their cashbooks and bank statements are accurate by reconciling them.
By applying compliance procedures, the auditor can obtain evidence as to whether a misstatement is likely. But by applying substantive procedures, the auditor gets evidence as to whether a misstatement actually exists. The auditor can arrange for suppliers to confirm from them in writing the details of the amounts owing at the balance sheet date.
The auditor could not use the result of the test of control to make the conclusion that the financial statements are true and fair view. The result of the test of control could only conclude the internal control context. Substantive testing is sometimes called detail testing where the main objective is to verify the balances, transactions, and disclosures of financial statements.
This helps understanding if reported figures are reasonable and in line with their observation. Evidence is required by auditors to verify the validity of financial records. It can either verify Substantive Procedures in Auditing: Definition & Explanation or provide support for the financial information that is presented. On the other hand, the evidence can contradict the financial information, which indicates errors or fraudulent behavior.
Though a walkthrough sheds light on those controls, a test of controls for effectiveness provides even greater support for the reliability of the data. Now let’s consider how auditors use substantive analytics to respond to the risk of material misstatement. As mentioned above, the substantive audit procedures are performed at the execution stage after auditors prepared audit planning. According to this article from Chron, physical inspection, confirmation from a third party, and inspection of records and documents are considered three of the most reliable audit procedures. Aside from them offering highly accurate information, they are also backed by audit evidence that is easy to double-check and validate. In recalculation, auditors recompute the transactions themselves and compare them to the initial financial statement or calculation of the company.
Differences from expected relationships may also indicate potential omissions when independent evidence that an individual transaction should have been recorded may not be readily available. The auditor’s objective in auditing related party transactions is to obtain evidential matter regarding the purpose, nature, and extent of these transactions and their effect on the financial statements. There are two categories of substantive procedures – analytical procedures and tests of detail.
Certain substantive analytics provide higher levels of assurance. For example, computing expected rental income provides high assurrance. If your client rents fifty identical apartments at $2,000 a month, the computation is easy and the assurance is high. The type of substantive analytic is dependent on the nature of the transaction or account balance. If a company rents fifty apartments at the same monthly rate, computing an estimate of revenue is easy. But if a company sells fifty different products at different prices, you may need to disaggregate the substantive analytical data. The video below provides an overview of substantive analytical procedures.
Substantive analytical procedures can, in certain cases, be more effective and efficient than a test of details. The number of samples in substantive testing is depending on many factors. For example, the audit approach that is considered by the audit manager or partner whether they decided to use a systematic approach, a substantive audit approach, https://online-accounting.net/ or else. In addition, the presence of an unexpected relationship can provide important evidence when appropriately scrutinized. In determining whether all necessary estimates have been made, the auditor should consider the industry in which the entity operates, its methods of conducting business, and new accounting pronouncements.