BFIN 331 - Chapter 6-12

Testing controls and substantive tests

Designed to see if controls work effectively to detect material misstatements at the assertion level.

designed to detect material misstatements at the assertion level.

When the auditor understand the client's business (IR) and their internal control (CR) structures.

they're made after gaining an understanding of the client during the planning stage.

- inspecting documents for evidence of authorization and check if the client did it right

- Observe various task of the client

- Enquiry how the client did their tasks

- Re-performing client procedures to test their effectiveness

- Substantive tests of transactions and balances

- analytical procedures

It is more efficient when the auditor has more reliance on client's accounting records.

• - Confirm from client's bank
• - Recalculate account balance
• - Inspecting document to verify amount recorded

The purpose (control or substantive) and procedure (inspection, observation, enquiry, confirmation, recalculation, reperformance, or analytical procedure)

Date, stage, interim, and year-end

what amount should auditor gather evidence

the risk that the sample chosen by the auditor is not a good representation of the population of testing. This causes the auditor to arrive at an inappropriate conclusion.

Risk that audit will be ineffective and inefficient

the risk that the auditor makes an inappropriate conclusion for reasons other than sampling issues.

Ex. use wrong audit procedure, the auditor was not trained properly, and rely on unreliable evidence.

A division of a population into groups of items with similar characteristics

the process designed, implemented, and maintained by those in charge with governance about the achievement of the entity’s objectives with regard to the reliability of financial reporting, effectiveness, and efficiency of operations, and compliance with applicable laws and regulations

• 1. Real
• 2. Recorded
• 3. Valued
• 4. Classified
• 5. Summarized
• 6. Posted
• 7. Timely

• Human error
• Ineffective understanding
• Collusion
• Program has overridden disabled

authorization, recording and custody

• management philosophy
• operating style
• organization structure
• assignment of authority
• responsibility

assignment of authority and responsibility

the entity's process for identifying and responding to business risks

safeguards over assets and records

controls that affect a particular transaction or group of transactions

wrong amount is not paid against an invoice

regular reconciliations of sales and receivables between the subsidiary and general ledger

inventory is recorded on the balance sheet that is non-existent

document the audit client’s accounting controls

narrative

discuss weaknesses in internal control and other matters discovered in the audit

• Management philosophy and operating style
• Commitment to competence
• Organization structure
• Assignment of authority and responsibility
• Internal audit

not one person is involved in a transaction from inception to completion. a work completed by an employee should be check by another.

this mean that the person authorizing a transaction should not be the person having control over the related assets

• 1. maintain reliable control that produces accurate information
• 2. safeguard assets and records from any destruction
• 3. Optimize the use of corporate resources
• 4. Prevent and detect errors and fraud

• if there a prior audit report of the client, review the prior document with the client and update with them
• making enquiries of the client
• read the client's policy and systems manuals
• examine documents and records
• observe the entity's activities and operations

to reduce the risk of misstatement due to error or fraud and make sure operation are processed effectively

• prevent or detect misstatements in the financial statement
• support the operation of the business's function of the control in place

• manual controls
• automated controls
• IT general controls
• IT-dependent manual controls

applied to transaction during normal processing to avoid errors to happen

a way to discover fraud or errors that occurred during the transactions process

management level reviews

performance indicators

reconciliations.

• it is accurate in capturing all relevant data
• identify all potential errors
• able to perform consistently and regularly
• include follow-up and correction on timely basis of any misstatements

purely manual that does not rely on IT for operation

rely on client's IT

has both manual and automated aspect of control

• Enquiry
• Observation
• Inspection
• Re-performance

Professional judgement

• 1. test operating effectiveness
• 2. test controls over program changes and/or access to data files

• carry forward all benefits of certain application control testing into future audit periods
• verify that there no change in the program, to ensure of no repeat audit procedures

usually at the interim date - especially when test are needed to relied upon to reduce substantive procedures

• test performed
• the purpose of the test of controls
• results of testing - exceptions found 
• conclusion tied to specific to test purpose

• Extent of documentation depends on complexity of client’s operations, systems, and controls
• Review impact of testing controls on rest of audit

• The type of control
• the frequency of the control being performed
• the level of assurance the auditor wishes to gain

impact the effectiveness of both application controls and IT-dependent manual controls.

• edit checks
• validations
• calculations

relies on testing the physical evidence

Auditor questions employee performing control, management about review of control

observes actual control being performed

Trace from reconciliation to accounting records or other documents

decrease detection risk, which result in more work for auditor

• are designed to detect material misstatements at the assertion level
• a way to obtain direct evidence as the completeness, accuracy, and validity of data, and the reasonableness of the estimates other information contain in the financial statements

• the risk of material misstatement
• Type of evidence required
• level assurance necessary
• the combination of alternative substantive test
• etc.

• influenced by the level of control risk
• typically at or near year-end
• control testing confirms a strong control system

• taking a balance from the underlying accounting records and verifying it by agreeing on the details to supporting evidence outside of the accounting records of the company
• test assertion existence & occurrence

• tracking a source document to the accounting records
• test completeness

• identify key item in a balance
• select largest transaction within a balance to obtain coverage of the total
• more persuasive other evidence available = less coverage key items

• if further testing require after key item testing
• depend on expectations of error and overall audit objective

used to obtain a level of confidence that key attributes in existence for the sample tested can be inferred to be in existence for entire population

• test of client prepared schedules
• tests using confirmations -> AR/bank 
• test of income statement account on classification

• primary (persuasive) tests of a balance
• provide at least a minimal level of support for the conclusion
• most effective test of a balance or at least reduce the extent of other substantive tests

• ratio analysis
• trend analysis
• break-even analysis 
• etc.

• when client's operations are diverse
• when client's budget process not well-controlled
• if industry data is unreliable or not comparable to client

• identify computation, comparison, to be made
• estimate probable balance or outcome
• perform procedures
• draw conclusions

• 1. persuasive evidence
• 2. corroborative evidence
• 3. minimal evidence
• 4. general audit evidence

• suitable for a primary test of balance
• conclude whether or not the account balance is free from material errors
• provide  a reasonable estimate of the balance
• no further procedures required

• support management representation = decrease the level of audit's skepticism
• allow the limit of the extent of other procedures in the area

• the nature of the test
• the level of assurance necessary
• the type of evidence required

if we are able to conclude that no further substantive tests need to be performed on the related account balance.

affects the persuasiveness of the evidence from analytical procedures.

that the auditor is able to draw a conclusion about the entire balance based on the conclusions they reached by testing the largest transactions

need to be responsive to the control risk assessment.

• are documented in the audit working papers.
• can be categorized as errors or judgemental misstatements.
• must be considered for their effect on the financial statements both individually and in aggregate.

an effective control environment.

provide a level of support for the conclusions reached.

comparison of direct labour costs and the number of employees with prior periods

• changes in the payroll rates
• the introduction of a new sales item
• increased costs of inventory

documents audit testing procedures to be undertaken

confirmation of accounts receivable

update findings from an interim date to year-end

agreeing the details in accounting records to supporting evidence

risk assessment procedures do not provide sufficient evidence that the population is free of material misstatements

confirms audit findings from other procedures

tracking a source document back to the underlying accounting records

• comparison of current year's amounts with previous years
• re-adding amounts on reports
• selecting and printing key items within a sample

calculating commissions paid as a percentage of sales

differences in the interpretation or application of accounting policies

re-evaluate the effectiveness of internal controls and overall assessment of risk

• determine by risk assessment
• Trivial or immaterial accounts are either ignored or subjected to analytical procedures only - prepaid expense
• when IR & CR are high

• determined by risk assessment
• low DR = more work required at year-end

• ensure procedures respond to specific risk from the client from both IR & CR factor
• set priority - what is important in this audit procedures

• Assertions:
• existence - bank confirmation
• classification - special disclosure requirement
• right & obligations - pledging restricts client's rights over cash
• valuation and allocation - only an issue when client have foreign currency bank account

• assertions:
• existence - positive confirmation 
• valuation & allocation - use subsequent receipts test and analytical procedures based on ageing
• (classfication - important because disclosure)
• cut-off - check near the year-end and after and trace back to subsequence ledger

• assertions: 
• existence - addressed by testing client's annual or cyclical inventory count
• valuation & allocation - view inventory at the inventory count allows
• rights & obligations - when consignment sales and complex purchasing contract

• vouching to invoice to verify initial cost
• vouching to sales details to verify cost of sales
• test impairment

• assertions:
• existence - verify items recorded in client's fixed asset register, physically sighting the asset, and focus on addition and disposals in later years
• valuation & allocation - consider appropriate cost, carrying value or fair value, and asset impairment - vouch initial cost to invoices, contracts, etc.
• rights and obligations - test periodically depending on the type of assets in the register 
• verifying registered titles, registration papers, and invoices

• Assertions:
• completeness - understatement of A/P - vouch payments after balance date to invoices to verify invoices dated prior to year-end are included in payables
• cut-off - verify both year-end and after year-end based on invoice date
• valuation & allocation

• Cut-off - both
• Occurrence - revenue
• Completeness - expense
• Classification - expense
• Accuracy - both

• Valuation & allocation - assets
• Existence - assets
• Right & obligations - assets
• Completeness - liability

gather evidence that the transaction recorded by the client actually took place and relates to the entity

all transactions have been recorded by the client

transactions are recorded by the client at the appropriate amount

transactions have been recorded by the client in the correct period

transaction is in correct account

evidence to recorded asset, liability, and equity items actually exist

evidence that recorded assets are owned by the entity and that recorded liabilities represent commitments of the entity

evidence that asset, liability, and equity items have been recorded at appropriate amounts and allocated to the correct accounts by the client

• work done to obtain an understanding of internal audit activities.
• a review of processes to generate estimates of provisions.
• interim reviews of activities such as monthly reviews of gross margins.

when the client has cash balances that are held in a foreign currency.

provides evidence about the existence of the accounts receivable.

• can provide evidence about the balance of accounts receivable.
• could reveal unusual delays in posting credits to debtors' accounts.
• can reveal cut-off problems.

can reveal insights into whether there are damaged, obsolete, impaired, or excess assets.

are usually tested for cut-off.

completeness, and valuation and allocation.

vouching a sample of payments made after year end to supporting invoices to ensure that amounts related to invoices dated prior to year end have been included in payables.

risk assessment for each significant account

existence

determining whether signatures on cheques are authorized

test the mathematical accuracy of the cash payments ledger

sending confirmation letters to the audit client’s customers

identify any slow-moving obsolete items of inventory

occurrence, completeness

• test the recording of acquisitions, transfers and disposal of inventory to the general ledger
• test transactions recorded in the perpetual inventory records to supporting documentation
• test transactions recorded in the general ledger inventory accounts to supporting documentation

analytical procedure

review reasonableness of the provision for depreciation to the prior year provision and the effects of additions and disposals

examine invoices, capital expenditure authorizations, and other data for purchases and disposals

the management is likely motivated to understate the balance

payables are stated at the amounts owed at year-end

completeness

transactions are subject to estimation processes of management

determine whether there are material misstatements

• BS account represent only recent transaction
• IS represent the entire reporting period transaction
• analytical procedures for IS rather than confirmations

• the risk of overstatement
• high overall IR = manipulation
• occurrence - test recorded sales are bona fide and have occurred
• accuracy - sales are recorded at correct amount, not overstated
• cut-off - risk that sales occur after year-end are recorded early

• risk to understatement
• Accuracy - vouching recorded amounts to documents or underlying account
• completeness and cut-off - verify that client has not understated expenses and cost of sales by deferring recording expenses to next period

• to determine if there are misstatements within the account balance and to quantify the amount of any misstatement
• understand why it occurred
• consider increase to sample size
• consider additional testing

some expenses are subject to specific disclosure requirements.

analytical procedures.

can be done by examining subsequent payments or unmatched invoices.

• try to understand why the error or exception has occurred.
• consider increasing the sample size.
• consider additional testing.

there are few required procedures for income statement accounts compared with balance sheet accounts

analytical procedure

regarding credit sales transactions for the last 30 to 60 days

sales might be overstated

occurrence, accuracy and cut-off

sales and sales returns & allowances

sales are stated at the appropriate amounts

completeness, accuracy and classification

occurrence

all costs and expenses in the income statement are properly supported as charges against the entity

sales expenses have been accurately recorded

all costs are recorded in the current accounting period

depreciation

• understand the reason for the occurrence of the exception
• quantify the misstatement
• continue testing

• 1. review planned procedures for proper and complete execution
• 2. determine all necessary matter
• 3. clear all outstanding review notes - to-do
• 4. remove all unnecessary documents
• 5. for multi-location audit, obtain all documents from other auditors and reviewed
• 6. consider materiality level used in audit
• 7. reconsider assessment of internal control at entity level and risk of fraud
• 8. revisit planning documentation to determine if all matters in plan have been addressed
• 9. perform analytical procedures on the adjusted financial statements
• 10. perform a review for contingent liabilities and commitments to ensure properly accounted 
• 11. perform subsequent events procedures

• the materiality of misstatements
• management responses
• previous experience
• the quality of information obtained
• persuasiveness of the audit evidence

will the entity remain in business for the foreseeable future

• require to record or disclose depend on whether the contingent liabilities are likely, probable, or measurable
• e.g. lawsuit
• require to search for any litigation and claim that may not be aware of that may give rise to a material misstatement

• financial statements are prepared on the basis of conditions existing year-end
• events that occur between year-end and the date of auditor’s report, and facts discovered after date of auditor’s report

• date financial statement approved by management
• date of auditor's report
• date financial statements are issued

• Events that provide additional evidence with respect to conditions that existed at year-end
• Accounting treatment: adjust financial statements for the effect of these events, where material

• Events that provide evidence with respect to conditions that developed subsequent to year-end
• Do not result in changes to amounts in the financial statements
• might be important for disclosure

• gain an understanding of and make evaluation of management processes to deal with subsequent events
• read board meeting minutes
• analyze latest interim results and other items
• enquiring of management, legal counsel, and board members about the subsequent event that might affect financial statements
• obtain written representations

• unintentional errors or due to fraud
• item's amount classification, presentation, or disclosure

• Significance of financial statement element affected by misstatement: inventory, A/R
• Significance of misstatements relative to known user needs
• Effect of misstatements on segment information, or other important portion of client’s business
• Effects of offsetting misstatements in different financial statement captions, e.g. cash, prepayments

schedule of uncorrected differences in order to assess overall effect on the financial statements and on individual items or balance

consider potential to reverse in next year

• change reported profit into loss
• affects management's satisfaction of requirements for award of bonuses and incentive compensation
• changes key ratios monitored by analyst

1.Evaluate audit evidence obtained

2.Evaluate effects of unrecorded misstatements and qualitative aspects of entity’s accounting

3.Evaluate whether the financial statements are properly prepared and presented according to standards

4.Evaluate fair presentation of financial statements in accordance with the applicable reporting framework: ASPE & IFRS

1.Title

2.Addressee: BOD & Shareholders

3.Introductory paragraph, identifying entity, states financial statements have been audited, identifies the title of each statement included in the complete financial statements, refers to summary of accounting policies and other notes, specifies the date and period covered by the financial statements

4.Management’s responsibility for the financial statements

–Establishing and maintaining internal controls

–Fair presentation of financial statements free from material misstatement

–Accounting policies and estimates

5. Auditor’s responsibility for the financial statements

–Express opinion based on audit

–Compliance with auditing standards

–Describe audit

–Audit evidence is sufficient and appropriate

6. Auditor’s opinion on whether the financial statements gives a true and fair view, or is presented fairly, in all material respects, in accordance with the applicable financial reporting framework (money maker)

7.Other reporting responsibilities

8.Auditor’s signature, either firm name, or personal name depending on legislative requirements

8.Date of report

9.Auditor’s address

may need to modify audit opinion to emphasize a certain matter or to express a qualified, adverse, or disclaimer of opinion

1.Significant uncertainty exists that should be brought to the reader’s attention

2.A limitation of scope of the engagement exists, or

3.There is a disagreement with those charged with governance

• does not affect auditor's opinion
• Applies when resolution of a matter is dependent on future actions or events not under direct control of the entity, but that may affect the financial statements, and the matter is disclosed in the financial statements

• the inability to perform procedures or an imposition by the entity
• timing problem
• record could be damaged or not complete
• restricted locations
• If problem is material to the financial statements, a qualified opinion or disclaimer of opinion is expressed

• regarding Accounting policies selected, Method of accounting policy application, and Adequacy of disclosures in financial report
• If material to the financial statements, a qualified or adverse opinion is expressed

the auditor should consider the reason for the misstatement or deviation.

an event that provides additional evidence with respect to conditions that existed at year end.

• consider whether the financial statements need changing.
• discuss the matter with management.
• take the action appropriate in the circumstances.

loss of plant as a result of fire or flood after year end.

selecting and applying appropriate accounting policies.

a significant uncertainty exists that should be brought to the reader's attention.

means that the auditor should write to the board of directors about any matters of governance interest arising from the audit of the financial statements.

reduce the risk of material misstatement in the financial statements to an acceptable level.

• knowledge of conditions and events obtained during planning and performing the audit.
• any material uncertainties about the entity’s ability to meet obligations as they fall due.
• changes in the industry in which the entity operates which could affect future operations.

• legal expense accounts for unexpected fluctuations
• minutes of meetings of those charged with governance
• correspondence with taxation authorities

• the effects of identified misstatements.
• the significance of financial statement elements affected by the misstatements.
• the risk of additional misstatements remaining undetected.

• evaluation of the audit evidence obtained
• evaluation of the effects of unrecorded misstatements
• evaluating the fair presentation of the financial statements

financial statements have been prepared in accordance with an applicable accounting framework.

include an emphasis of matter in the audit report describing the inconsistency.

an unqualified opinion.

responsibilities ensuring that the entity achieves its objectives regarding reliability of financial statements, effectiveness and efficiency of operations and compliance with laws.