Substantive Tests of Transactions and Account Balances Edited

8/18/2019 Substantive Tests of Transactions and Account Balances Edited

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Substantive Tests ofTransactions andAccount Balances

Agaton . Baccay . Cabezas . Elemos . Gonzales . Romen


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Audit Procedures

Performed to obtain audit evidence used to drawreasonable conclusion as to whether the financial

reports of a client follow GAAP and to support or

contradict management assertions


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Types of AuditProcedures

.Ris!"assessment procedures

#.$est of Controls

%.&ubstantive procedures


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SubstantiveProcedures

$est accounts or classes of transactions to

detect material monetary error or

misstatements in financial statement

assertions


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Nature of Substantive

Procedure' Relative effectiveness of the procedure tosubstantiate the particular evidence

warranted by the assertion being tested' Responsive to assessed ris! of

misstatement from ris! assessment

procedures' (ncludes analytical procedures and test of

details


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Nature of SubstantiveProcedure

#.$est of )etailsa.$est of Balances

b.$est of $ransactions

c.$est of )isclosures


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Timing of SubstantiveProcedures

*ear"end+ interim date or subse,uent to year"end

Note- ore assurance may be obtained by shiftingaudit procedures from interim to year"end sinceperformance at interim date increases audit ris! becausemisstatements may arise in the remaining periodbetween date of tests and year end. $his ris! may becontrolled by-

a.Performing additional audit procedures that cover theremaining periods

b.Relying on the effectiveness of internal control to

prevent misstatements


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Nature of SubstantiveProcedure

.Analytical Procedures' Part of further audit procedures

' Based on the result of the ris!"

assessmentprocedure


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Extent of SubstantiveProcedures

Ris! of material misstatement

/

0eeded e1tent of substantive procedure

E1amining more items increases the e1tent

of substantive procedures. $herefore+sample size must be sufficient to restrict

audit ris! to a low level


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Concept of SubstantiveTest & Audit Program

Audit Program'2ist of comprehensive audit procedures to enable

the auditor to gather sufficient audit evidence toindicate the satisfaction of audit ob3ectives of

particular accounts

'ust be concise and understandable to enable

anyone who e1amines the wor!ing papers to

evaluate the wor! performance of the auditor


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Concept of SubstantiveTest & Audit Program

Substantive Test

')esigned to meet the audit ob3ectives set

by the auditor and to obtain sufficient auditevidence to provide a reasonable basis for

an opinion


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Categories of SubstantiveTest

.$est of )etailsa.$est of $ransactions

b.$est of Balances

#.Analytical Procedures


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Test of Details

b!ective- detect material misstatements in thefinancial statements

Common audit procedures include-

.(n,uiry

#.Comparison

%.Confirmation

4.5bservation

6.Recalculation

7.E1aminationa.$racing

b.8ouching

9.Analytical Procedures


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Test of Transactions

' )irect test of transactions

' Concerned on whether transactions are

correctly accounted+ recorded and

summarized during the period and to

determine whether any monetary errors

have occurred

' :ocus on individual transaction cycles that

ma!e up the balance


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Test of Details

' Concerned with monetary errors in theaccount balances

' &ubstantiate the ending balance of an

account


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Analytical Procedures

' (nvolve evaluations of financial statementinformation by a study of relationshipsamong financial and nonfinancial data.

' Analytical procedures are an importantpart of audit process and consists ofevaluations of financial information made

by a study of plausible relationshipsamong both financial and nonfinancialdata.


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Nature of AnalyticalProcedures

$echni,ues used in performing analytical

procedures range in sophistication from

straightforward analysis of trends and

ratios to comple1 mathematical modelsinvolving many relationships and data

from many previous years


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Timing of AnalyticalProcedures

' At the planning stage the ob3ective of

analytical procedure is to help the auditor

identify unusual transactions+ evens or

amounts that might affect the fairness ofthe financial statements.

' Planning analytical procedures are also

used to increase the auditor;sunderstanding of the client;s business.


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Extent of AnalyticalProcedures

' A primary measure of the effectiveness ofan analytical procedure is its precision.Precision depends on a number of factors+

including the predictability of therelationships+ the techni,ue used todevelop the e1pectation+ and the reliabilityof the underlying data used.

' $he reliability of the underlying data thatare used for analytical procedures may beevaluated by considering the source of thedata


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Audit Trail

(n developing audit procedures+ the auditor isassisted by the organized manner in whichaccounting systems record+ classify andsummarize data. $he flow of accounting data

begins with the recording of thousands ofindividual transactions on such documents asinvoices and chec!s. $he information recorded onthese original


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T e Au tor o o#s some as csteps in using analytical

procedure during t"e auditexamination$

' (dentify the account balance or ratio of

interest' )evelop an e1pectation for the account

balance or ratio' Compare the recorded >unaudited?

account balance or ratio to the e1pectation' (nvestigate any significant differences


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%eneral AuditProcedures

' $he following are fre,uently used auditprocedures. Because they are in generalform+ each procedure in an audit program

should specify the account balance ortransaction to which it applies.

. Consider internal control+ assesscontrol ris!.

#. Evaluate whether transactions areproperly recorded in conformitywith GAAP.


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%. Reconcile detail records and data with thegeneral ledger.

4. Confirm and observe for proper segregationof duties and actual practice.

6. $est posting from the 3ournals to the ledgers.

7. Compare an account;s beginning balance with

the ending balance from the previous period.9. &can the accounts for unusual items.

@. (nvestigate unusual items.

. $est for proper authorizations.

. 8ouch source documents.

. (n,uire significant accounts and events.

#. $est for ade,uate disclosures.


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Audit Trail' a trail of evidence that lin!s the thousands

of individual transactions composing a

year;s business activity with the summaryfigures in :&

' consists of source documents+ 3ournal

entries and ledger entries.


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elations"ip Bet#een TC

and ST' $5C provide auditors with evidence as to

whether prescribed controls are in use and

operating effectively.

' $he results of these tests assist the

auditors in evaluating the li!elihood thatmaterial misstatements have occurred.


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' &ubstantive procedures are designed to

detect material misstatements if they e1ist

in the :&.

' $he amount of substantive testing done by

the auditors is greatly influence by theirassessment of the li!elihood that material

misstatements e1ist.

elations"ip Bet#een TC

and ST


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S'BSTANT(AT(N )ACC'NT BA*ANCES


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Substantiation of Account

Balances

$he main purpose of the auditor;s ris!

assessment process+ including theassessment of control ris!+ is to determine

the nature+ timing+ and e1tent of the audit

wor! necessary to substantiate the

account.


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Existence

$he auditor selects from items contained inthe accounting records and obtains

evidence that supports them.


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Existence

' Cash on hand+ ar!etable &ecurities+ and(nventories " ay be verified by physicalobservation or inspection+ and by vouching

' Assets in custody of others " ay also be

done through direct confirmation with thirdparties

' (ntangible Assets " Gather evidence thatcosts have been incurred and these costsrepresent future economic benefits


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ig"ts To T"e Assets

' $he auditor must ascertain that the assetsand liabilities are ownedcontrolled by theclient.

' Dowever+ with other assets+ such as PPEand inventories+ physical e1aminationestablishes e1istence but not ownership

$o verify the rights to plant assets+

auditors must inspect documentaryevidence such property ta1 bills+

purchase documents+ and deeds


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ig"ts to t"e Assets

' &ame procedures that verify e1istencealso establish the company;s rights to theasset

E1ample-

Confirming balances in ban! accountsestablishes e1istence of cash and thecompany;s ownership rights to that cash.


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Completeness

' $he auditor identifies evidence indicating itemsthat should be included in the account.

' (n here+ the auditor is loo!ing for assets

ac,uired but not recorded

$racing is one of the tests for

completeness

5bservation and physical e1amination

may also be done

Audit Procedures


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any tests for unrecorded assets involve tracingfrom the


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+erifying T"e Cut,o-

' Refers to the process of determining thetransactions occurring near the balance sheetdate are assigned to the proper accounting period

' (mpact of cut"off errors varies with the nature ofthe error

' Auditor must review transactions recorded shortly

before and after the balance sheet date toascertain that these are assigned to the properperiod

Review chec!s+ receiving reports andshipping documents

+ l i d


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+aluation andAllocation

' $he auditor considers the appropriatenessof the basis of the valuation of the assetsor liability.

' $he auditor must not only establish thatthe accounting method used to value a

particular asset is generally accepted+ butalso determine that the method ofvaluation is appropriate and properlyapplied in the circumstances.


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Common procedures used-

:or assets valued at cost+ vouch the ac,uisition cost ofassets to paid chec!s

(f asset is sub3ect depreciationamortization+ auditor

must evaluate the reasonableness of the costallocation program and verify computation ofunallocated cost

:or assets valued at fair value+ fair values are auditedby comparison to prices on e1isting mar!ets+ or by

e1amination of valuation models used to develop thevalues

Auditor must test the clerical accuracy of underlyingrecords to determine that they accumulate to thetotals appearing in the general ledger+ thus+ also thefinancial statements

+aluation of Assets


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)inancial Statement

Presentation andDisclosure

$he auditor must perform procedures toensure that the :& presentation conforms

to the re,uirements of authoritative

accounting pronouncements and the

general principle of ade,uate disclosure.


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)inancial Statement

Presentation andDisclosure

Procedures falling into this category include-

Review of subse,uent events

&earch for related party transactions

(nvestigation of contingencies

Review of needed disclosures


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Substantive Audit of

Cas"


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T i l S b t ti A dit


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Typical Substantive AuditProcedures for Cas"

' Review disclosures for compliance with GAAP' (n,uire on management concerning compensating

balance agreements and restrictions on cash' &end confirmation letters to financial institutions

$he form re,uests information on depositsand loans

now that the form is designed tosubstantiate evidence primarily on the

e1istence assertion+ and not to discover orprovide assurance about accounts not listed onthe form



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' Count cash on hand at year end' Prepare a ban! transfer schedule for the last

wee! of the audit year and the first wee! of thefollowing year to disclose misstatements

resulting from !iting A ban! transfer schedule shows the datesof all transfers of cash among the client;svarious ban! accounts

Prepared by using ban! statements for theperiods before and after year"end and byusing the firm;s cash receipts anddisbursements 3ournal




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' Review the cut"off of cash receipts anddisbursements around year end

' Review ban! statements

' Perform analytical procedures

ay include comparison to prior yearcash balances

$hese procedure help verify thee1istence and completeness ofcash transactions




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' Review year"end ban! reconciliations

Auditors generally prepare either a # or 4"columnban! reconciliation for the difference betweenthe cash per ban! and per boo!s

Fhen the level of control ris! is assessed as-2ow - substantive procedures might be confined toscanning the client reconciliations and comparingbalances per ban! to ban! confirmations

Digh- the auditor e1tends the substantive procedures

in testing the client;s reconciliation by e1amining theindividual details of reconciling items




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' 5btain a cut"off ban! statement

A ban! statement for the first @" businessdays after year"end

Primary purpose of which is to help auditors

verify reconciling items on the year"end ban! reconciliation

&tatement is sent by the ban! to the auditor ' :oot summary schedules of cash and agree their total

to the amount which will appear on the financial

statements' Reconcile summary schedules of cash to the general

ledger ' $est translation of any foreign currencies



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Substantive Audit for

eceivables


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Typical Substantive AuditProcedures for eceivables

' Review disclosures for compliance with

GAAP

' (n,uire of management about pledging+ or

discounting of receivables

' Review loan agreements for pledging and

factoring receivables



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E1tent and method of confirmation is

determined by-' Effectiveness of internal control

' Possibility of disputes+ inaccuracies+ and fraud inaccounts

' E1pected degree of cooperation by the debtors

' Probability that debtor will be able to confirm the

amounts involved

' ateriality of amounts involved


T pical S bstanti e A dit


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$wo types-' Positive form once debtor has been selected+

auditor must obtain evidence and as! debtor torespond whether or not they agree with information

as to amount owed in re,uest. $here will be follow"up procedures such as second re,uest andchec!ing invoices to shipping documents to provesale for any non"response.

' Negative form re,uests debtor to respondwhen they disagree with amount shown. Alternative procedures to debtors confirmationsinclude e1amining evidence of subse,uent cashreceipts and e1amining sales and shippingdocuments.


Typical Substantive Audit


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' Confirm accounts and notes receivablesby direct communication with debtors

Confirmation of AR is a GAAP

procedure therefore+ non"performance of which mustdocument the reason

Confirmation re,uests must bealways mailed by the auditor andresponses must be received

by the auditor




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' (nspect notes on hand and confirm those not onhand by direct communication with holders

' 8ouch receivables to customer orders+ sales

orders+ invoices+ shipping documents and creditmemos

' Review the cut"off of cash receipts and salesaround year"end

A sale is properly recorded when titlepasses on the items being sold. Be carefulwith :5B &hipping Pt. and :5B )estination.




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' :oot the accounts and notes receivable subsidiary ledger

' Reconcile subsidiary ledgers to general ledger controlaccounts

' E1amine cash receipts subse,uent to year"end

' Age accounts receivable

Aging schedule is used to address the receivablevaluation assertion

' )iscuss ade,uacy of the allowance for doubtful accounts

with management and credit department and compare itto historical e1perience

' Consider changes in economy




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' (n,uire about factoring of receivables

' Perform analytical procedures

$ypical ratios include- H Gross profit rate H Accounts receivable turn"over

H Ratio of accounts receivable

H Rate of accounts receivable written"off

' Ratio of interest revenue to notes

receivable



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Substantive Audit of )ixed

Assets


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' Perform search for unrecorded retirements and obsoletee,uipment

' Review any leases for proper accounting

' Review minutes of the board of directors >and

shareholders?' Perform analytical procedures

Comparison of total cost of PPE and divided bycost of goods sold

Comparison of repairs and maintenance on a

monthly and annual basisComparison of ac,uisitions and retirements for the

current year with prior years

Typical Substantive Auditfor )ixed Assets



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' Review disclosures for compliance with GAAP

' (n,uire from management concerning any liens andrestrictions on PPE

' Review loan agreements for liens and restrictions on

PPE' (nspect ma3or ac,uisitions of PPE

' 8ouch additions and retirements to PPE

)isposals may occur due to retirement or theft of

PPE items&imple retirements of e,uipment are often difficultto detect since no 3ournal entry may have beenrecorded to reflect the event



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' Inrecorded retirements may be discoveredthrough

' Perform search for unrecorded and retirementsand obsolete e,uipment

' E1amination of changes in insurance policies

' Consideration of the purpose of the recorded ac,uisition

' E1amination of property ta1 files

' )iscussions

' 5bservation' E1amination of debits to accumulated depreciation and

credits to miscellaneous revenue accounts

' (n,uiry of plant manager




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' 5btain or prepare an analysis of repairsand maintenance e1pense and vouchtransactions

' :oot PPE summary schedules' Reconcile summary PPE schedules to the

general ledger

' Recalculate depreciation' Consider any conditions that indicate that

assets may be impaired



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*ong,term (nvestment

Simultaneous


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Simultaneous+eri.cation

Because of the li,uid nature of securities+

the auditor;s inspection is generally

performed at year"end simultaneously with

the audit of cash+ ban! loans+ and otherrelated items.

Desirable Client


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Desirable ClientControls

' $he treasurer should authorize purchases andsales up to a certain value. After that value hasbeen reached+ transactions should beauthorized by the board of directors

' $wo individuals should be present when accessto securities is necessary

' Recorded balances for investments should

periodically be compared with the actualsecurities held by individuals independent of thefunction.


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Substantive Testing of

*ong,term (nvestment

Assertion Audit b!ective Audit Procedures


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A.ExistenceorOccurrence

-To determine thatinvestment insecurities (shares,bonds, notes)

physically exists andin loans andadvances exist.

-Obtain or prepare a listing ofsecurities and investments oned bythe company and related revenueaccounts and reconcile to the general

ledger-!nspect securities on hand

-Obtain con"rmation of securitiesheld by others

#.$ompleten

ess

-To determine that

investments that areall included in thestatement of"nancial position

-%ouch selected purchases and sales

transactions of securities during theyear.

C/ig"tsandbligations

,To determine t"att"e company o#nsor "as o#ners"iprig"ts to allinvestmentsincluded in t"estatement of.nancial position

,+erify t"e client0s cuto- ofsecurities transactions

,Perform analytical procedures

,Compute independentlyrevenue from securities

&.%aluation

or Allocation

-To determine that

investments are

-&etermine that maret value of

securities at statement of "nancial


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Accounts Payable and

Purc"ases

Con.rmation of


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Con.rmation ofPayables

' Confirmations may be sent to vendors

' Auditors are primarily concerned about thepossibility of understated payables called


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*iabilities



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E.Existenceor Occurrence

-To verify thataccounts payablerepresent liabilities of

the entity

-Obtain from the client a listing ofaccounts and notes payable as atyear-end and reconcile to the

general ledger-%ouch recorded liabilities tovendor*s statements

-$on"rm recorded liabilitiesdirectly ith suppliers andcreditors. !nvestigate di+erences in

liabilities reported in thecon"rmations ith the recordedboo amounts.

-Examine boo con"rmations forloans.

)/Completeness

,To verify t"at allaccounts payable

are recorded in t"eproper period atyear,end/ (dentifytrade accountspayable in searc"for unrecorded

liabilities/

,Perform purc"ases cuto-examinations

,Test for unrecorded liabilities,Perform analytical procedures


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'.ights and

Obligations

-To verify that accounts payable

represent the entity*s liabilities

-evie

documentationin client*s "les

-Examinesubseuentpayments tocreditors

1/+aluationor Allocation

,To verify t"at accounts payables arerecorded at t"e proper amount

,+ouc"accountspayablesc"edule

,Test

computationof accrued orprepaidinterest


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Payroll

Special Audit


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Special AuditConsiderations for Payroll

Fhen control ris! is assessed as low for

assertions related to payroll+ substantive

test of payroll balances most li!ely would

be limited to applying analyticalprocedures and recalculating payroll

accruals.


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Payroll


! Existence To verify that salaries payable evie payroll checs


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!.ExistenceorOccurrence

-To verify that salaries payablerepresent liabilities of the entity

-evie payroll checsand banreconciliations

-evie the payroll

register-Examine personnelrecords

-Observe thedistribution of thepaychecs on asurprise basis

.$ompleteness

-To verify that all salaries payableare recorded in the proper period atyear-end. !dentify trade accountspayable in search for unrecorded

liabilities.

-evie time reportsand pieceor orcommission records

/.ights andObligations

-To verify that salaries payablerepresent the entity*s liabilities

-%erify payrolldeductions

-evie accounting forunclaimed ages

-Examine payroll cuto+

* +aluation or To verify t"at salaries ecomputed


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*/+aluation orAllocation

,To verify t"at salariespayables are recorded att"e proper amount

,ecomputedpayroll register

,+ouc" items fromt"e payroll register

to employee timecards

,bserve t"e use oft"e time cloc2s byt"e employees

,Compare payrollexpenses #it" priorperiods andinvestigatedi-erences

,Perform analytical

procedures,evie# t"e resultsof audits of relatedpension and pro.t,s"aring plans


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*ong,term Debt


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Typical Substantive AuditProcedures for *ong,termDebt

>ie. ortgage Payable+ Bonds Payable+0otes Payable H 2ong"term?


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*ong,term Debt


2 Existence or -To verify that additional -Obtain an analysis of


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2.Existence orOccurrence

-To verify that additionaldebt obtained or retireddebt actually occurred

-Obtain an analysis oflong-term debt accountsand related interest,premium, and discount

accounts-evie debt agreementsand con"rm ith payeesthe principal amount,maturity date, interestrate, etc.

-!nspect bonds redeemedor surrendered during theperiod

3.$ompleteness -To detect unrecordeddebt

-Trace authori0ation forissuance of debt to

credits to the long-termdebt account

-%ouch borroing andrepayment transactionsand revie transactionsto supporting documents

occurring near year-end


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/ig"ts andbligations

,To verify t"at long,term debt actuallyconsists ofobligations of t"eentity

,evie# minutes ofboard of director0smeetings

,evie# paymentsand rene#als aftert"e statement of

.nancial positiondate

.%aluation or Allocation -To determine that thelong-term debts arerecorded at the proper

amount

-ecalculate interestexpense andamorti0ation of

premium or discount, ifany

-Ascertain the amountof long-term debtmaturing ithin oneyear


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Substantive Testing ofE3uity


4 Existence or To determine the validity of Obtain schedules of


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4.Existence orOccurrence

-To determine the validity ofrecorded shareholder*s euitybalances and hether thetransactions actually

occurred.

-Obtain schedules ofshareholder*s euityaccounts and reconcileto the general ledger

balances-evie authori0ationand terms of shareissuances

-$on"rm sharesoutstanding ithregistrar on share andtransfer agent

-!nspect sharecerti"cate boo

-!nspect certi"cates of

shares held in treasury

.$ompleteness -To determine hetherrecorded shareholder*s euityaccounts re5ect all data thatshould be recorded

-!n addition to theabove mentionedprocedures, performanalytical revie

procedures


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S/ig"ts

andbligations

,To determine #"et"er t"e entity

"as t"e aut"ority and execute t"es"are"olders e3uity transactions4ie/ 5"et"er s"are capital #aslegally issued and s"are"olders"ave a legal claim on corporateassets at t"e statement of .nancial

position date6

,evie#

articles ofincorporation and by,la#s

,7a2ein3uiries oflegalcounsel

T.%aluationorAllocation

-To determine hether the shareholder*seuity balances are shon in the properstatement accounts in accordance ith

A6786

-%ouch sharecapitalentries,

dividendentries, andentries toretainedearnings.


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T"at in All T"ings8 %od

may be glori.ed9

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Substantive Tests of Transactions and Account Balances Edited

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