Chapter 12, Designing Substantive Procedures Chapter 12, Designing Substantive Procedures

1. Chapter 12
Designing Substantive
Procedures
Prepared by Dr Phil Saj
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2. Learning objectives
1. Describe how various risk factors relate to the type of
potential misstatement.
2. Explain the process for determining the appropriate
level of substantive procedures based on the
assessment of detection risk, inherent risk and control
risk.
3. Explain how the auditor designs substantive procedures
for each audit.
4. Indicate how the nature, timing and extent of
substantive procedures is varied to achieve an
acceptable level of detection risk.
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3. Learning objectives
5. Explain how computer-assisted audit techniques may be
used as substantive procedures.
6. Describe and apply a general framework for developing
audit programs for substantive procedures.
7. Explain which substantive procedures may normally be
included in an audit program.
8. Indicate special considerations when designing
substantive procedures.
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4. Assessing the risk of material
misstatement
The auditor must evaluate the type of potential
misstatements that may occur.
Must evaluate the magnitude of potential misstatements.
Must evaluate the likelihood of potential misstatements.
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5. Determining detection risk
Detection Risk (DR) is the risk that the auditor’s
substantive procedures will not detect a material
misstatement.
It is directly related to the substantive procedures
performed in an audit:
DR = AR___
(IR x CR)
For a given level of Audit Risk (AR) specified by the
auditor, DR is inversely related to the assessed levels
of Inherent Risk (IR) and Control Risk (CR)
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6. Audit Strategy, Detection Risk
and Substantive Test
Planned
Detection Risk
Audit
Strategy
Substantive
Test
Low or very
low
Predominantly
substantive
approach
High
Moderate or
high
Lower assessed
level of control
risk approach
Low
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7. Designing substantive procedures
Substantive tests are procedures that:
provide evidence which supports the
fairness of each of management’s
financial statement assertions; or
reveal monetary errors or misstatements
in recording or reporting of transactions
and balances.
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8. Designing substantive procedures
Designing substantive procedures involves the
consideration of an assessed level of inherent
and control risk in determining the nature,
timing and extent of the tests required to reduce
audit risk to an acceptably low level.
Refer ASA 330 The Auditor’s Procedures in
Response to Assessed Risks.
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9. Nature of substantive procedures
Nature refers to type and effectiveness of audit
procedures to be performed.
If the assessed detection risk is low, the auditor
would need to use more effective and more
costly procedures.
If the assessed detection risk is high,
the auditor can use less effective and less costly
procedures.
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10. Timing of substantive procedures
The timing of substantive procedures is
dependent on the level of detection risk.
If detection risk is HIGH, then certain
procedures may be performed a few months
before the end of the year.
If detection risk is LOW, all substantive
procedures relating to account balances will be
performed at or near the balance date.
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11. Timing of substantive procedures
However, early substantive testing should not be done
unless:
tests of control have provided convincing
evidence that internal controls are effective.
the auditor is satisfied that the internal control
structure during the remaining period has been
effective.
there are no conditions or circumstances that
may predispose management to misstate the
financial statements in the remaining period.
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12. Timing of substantive procedures
The entity’s accounting system will provide
information concerning significant unusual
transactions and significant fluctuations that
may occur in the remaining period.
Where early substantive testing is used, it does
not eliminate the need for additional substantive
procedures at the balance date.
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13. Extent of substantive procedures
The amount of evidence can vary by changing
the extent of substantive procedures.
‘Extent’ means the number of items or sample
size.
It is dependent on the level of detection risk.
If level of detection risk is LOW (HIGH), then
more (less) evidence is needed.
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14. Types of substantive procedures
Analytical procedures
Tests of details of transactions
Tests of details of balances
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15. Analytical procedures
ASA 520 defines analytical procedures as evaluations of
financial information made by a study of plausible
relationships among both financial and non-financial
data.
Encompasses investigation of identified fluctuations and
relationships that are inconsistent with other relevant
information.
ASA 520 — requires the use of analytical procedures
during the planning stage (as risk assessment
procedures) and at the end of audit stage (overall
review).
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16. Analytical procedures
Analytical procedures may also be applied as
substantive procedures to gather relevant audit
evidence to support management’s assertions.
Examples include comparisons of an entity’s financial
information with:
comparable information for prior periods;
anticipated results of the entity, such as budgets
and forecasts; or
expectations of the auditor, such as an estimation
of depreciation.
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17. Analytical procedures
The extent of reliance on analytical procedures depends
on:
materiality;
other audit procedures;
the accuracy of predicted results; and
inherent and control risks.
Analytical procedures are often considered less
effective than tests of details and are used as a
supplementary technique.
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18. Tests of Details
Mainly involves tracing and vouching
SUPPORTING/
SOURCE
DOCUMENT
e.g. Remittance
advices
(risk of
understatement)
ACCOUNTING
BOOKS
e.g. Cash
Receipts Journal
TRACING
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19. Tests of Details
(risk of
overstatement)
ACCOUNTING
BOOKS
e.g. Purchases
Journal
SUPPORTING/
SOURCE
DOCUMENT
e.g. Supplier
Invoice
VOUCHING
Mainly involves tracing and vouching
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20. Test of details of transactions
Test of details of transactions are tests to obtain
evidence of a sample (or all) of the individual debits and
credits that make up an account, to reach a conclusion
about the account.
These tests focus on finding monetary errors in
individual debits and credits in an account.
Cut-off tests are a special category of tests of details of
transactions that are related more to the closing balance
than to transactions.
The purpose of cut-off tests is to ensure completeness
and occurrence.
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21. Test of details of balances
Test of details of balances focus on obtaining
evidence directly about an ending account balance.
An example would be verifying amounts owed by
an individual customer recorded in the
accounts receivable ledger, by confirming the
balance directly with the customer
Extent of the testing is dependent on the outcome of
tests of controls and tests of details of transactions.
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22. Computer-assisted audit techniques as
substantive procedures
In designing substantive audit procedures, the auditor may
decide that it is effective and efficient to use computer-
assisted audit techniques (CAATs) as an audit tool.
Examples of substantive auditing procedures that can be
performed or helped by the use of CAATs, include:
sampling programs to extract data for audit testing;
recalculating interest or the extraction of invoices over
a certain value from computer records;
identifying inconsistencies or significant fluctuations;
re-performing calculations performed by the entity’s
accounting systems.
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23. Computer-assisted audit techniques
as substantive procedures
Generalised audit software can be used in performing
calculations, selecting samples, identifying records
meeting specified criteria, comparing data in different
fields, and producing reports
examples in practice include checking the
ageing of accounts receivables (30/60/90 days
and over) and selecting accounts for
confirmation.
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24. Computer-assisted audit techniques
as substantive procedures
Customised audit software
Used when the client’s computer system is not
compatible with the generalised audit software or
where the auditor wants to perform a function that the
generalised software cannot do, and thus customised
audit software must be written.
Utility programs
These programs are generally part of the client’s
computer system and can perform tasks such as
sorting, creating and printing files.
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25. Developing audit programs for
substantive procedures
An audit program is a list of auditing steps to be performed.
Audit programs should provide:
an outline of the procedures to be carried out;
identification of the preparer and the reviewer;
date of the audit work and review;
a basis for coordinating, supervising and controlling the
audit; and
a record of the work performed.
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26. Assertions, audit objectives and
substantive procedures
According to ASA 500.22, assertions fall into the
following categories:
Assertions about classes of transactions
Occurrence
Completeness
Accuracy
Cut-off
Classification
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27. Assertions, audit objectives and
substantive procedures
Assertions about account balances
Existence
Completeness
Rights and Obligations
Valuation and Allocation
It is important to make the distinction between
assertions that relate to each category as this
will later impact the appropriateness of audit
procedure design.
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28. Special considerations in designing
substantive tests
Income statement accounts
Accounting estimates including fair value
Related parties
Inventory and segment information
External confirmations
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