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CHAPTER 12

AUDIT PROCEDURES IN RESPONSE TO


ASSESSED RISKS: SUBSTANTIVE TESTS
12-19. (Estimated time - 15 minutes)
Example Risk Factor
1.

The company is in an industry that is experiencing


economic difficulty and intense price competition.
2. The company has recently changed the nature of its
product and is bundling software with other services
to customize and implement software and related
controls.
3. Analytical procedures for a manufacturer show a
significant increase in both profit margins and
inventory turn days.
4. Analytical procedures for a retailer show significant
decreases in both profit margins and inventory turn
days.
5. Senior management has sent a very strong message,
and offered increased incentives, to middle
managers to meet financial targets.
6. An employee in a small to medium sized business
responsible for cash disbursements did not receive
an expected promotion and pay increase.
7. A construction industry client uses the percentage of
completion method to recognize revenue and
expense on current projects.
8. A company is experiencing working capital and
going-concern problems.
9. The client has a strong control environment and
good controls over the existence of inventory.
10. The client has weak computer general controls
including poor controls over the approval of system
changes.

Audit Strategy
1. Primarily Substantive Approach
2. Primarily Substantive Approach

3. Primarily Substantive Approach


4. Primarily Substantive Approach
5. Primarily Substantive Approach
6. Primarily Substantive Approach
7. Primarily Substantive Approach
8. Primarily Substantive Approach
9. A Lower Assessed Level of Control Risk
Approach
10. Primarily Substantive Approach

12-20. (Estimated Time 30 minutes)


Example Risk Factor
1.
2.
3.

4.

5.
6.

The client has a strong control


environment and good controls over the
existence of inventory.
The client is in an industry that has both
significant regulatory oversight and
complex regulations.
The client has recently experienced
turnover in its information technology
group resulting in decreased segregation
of duties and a deterioration of computer
general controls.
The client is a private university with
primarily full time students, a small
amount of receivables at year-end, and
good internal controls over revenues.
A companys business plans are
dependent on the success of entering new
foreign markets with existing products.
The client has used significant borrowing
to fund expansion in a competitive
industry and has a narrow tolerance range
regarding debt covenants.

7.

Analytical procedures for a manufacturer


show significant increases in both profit
margins and inventory turn days.
8. Inventory items are small in size and high
in value.
9. The telecommunications client is in a
capital intensive industry and fixed assets
additions involve complex accounting
issues.
10. The audit team has experience several
attempts by management to justify
marginal or inappropriate accounting on
the basis of immateriality.
11. Analytical procedures for a manufacturer
show significant increases in both revenue
growth and accounts receivable turn days.

Type of Potential
Misstatement
Controls are relevant to the
existence of inventory

A lower assessed level of


control risk approach

Misstatements may occur in


many assertions or accounts

A primarily substantive
approach.

Misstatements may occur in


many assertions or accounts

A primarily substantive
approach.

Issues relate primarily to the


occurrence of revenues and
the existence of receivables.

Predictability of
transactions may allow for a
response to lower inherent
risk and analytical
procedures.
A primarily substantive
approach.

Issues relate primarily to the


occurrence of revenues and
the existence of receivables.
Issues relate both to the
disclosure assertion for longterm debt and to other
assertions affected by debt
covenants.
The existence of inventory.
The existence of inventory.

Audit Strategy

A primarily substantive
approach.

A primarily substantive
approach.

Valuation and allocation for


fixed assets.

A primarily substantive
approach.
A primarily substantive
approach.

Issues may have a pervasive


impact on multiple assertions

A primarily substantive
approach.

Revenue recognition or the


net realizable value of
receivables.

A primarily substantive
approach.

12-24. (Estimated Time 25 minutes)


Objective
1.
2.
3.

Assertion
BAO - C
BAO E
PDO C&O

Objective
8.
9.
10.

Assertion
BAO -C
BAO - E
DAO

4.
5.
6.
7.

BAO - VA
BAO - VA
BAO - RO
BAO - RO

11.
12.
13.
14.

C&U
BAO - VA
DAO - CU
DAO - CU
DAO - CU

12-25. (Estimated Time 20 minutes)


Note: The student is required to list only one type of test, type of evidence, and assertion for each
auditing procedure. In some cases, alternative answers are indicated in the tabulation below.
1.

Audit Procedure
Count cash on hand

Type of Test
T of D of balances

2.

Confirm accounts receivable.

T of D of balances

Audit Objective
BAO - Existence,
Completeness, Valuation and
allocation
BAO - Existence

3.

Vouch plant asset additions to


purchase documents.
Recalculate accrued interest on
notes payable.

T of D of transactions

TAO - Occurrence, Accuracy

T of D of balances

5.

Inquire of management about


pledging of plant assets as
security for long-term debt.

T of D of disclosures

6.

Compute inventory turnover


ratio.

Analytical procedure

7.

Vouch ending inventory pricing


to purchase invoices.
Review client-prepared bank
reconciliation.

T of D of balances

Verify accuracy of accounts


receivable balance and
agreement with subsidiary
ledger.
Obtain details of accounts
receivable subsidiary ledger and
reconcile to the general ledger.
Compare statement disclosures
for leases with GAAP.

Initial procedures

BAO - Existence,
Completeness, Valuation and
allocation
DAO - Completeness (of
disclosures), DAO
Occurrence and Rights and
Obligations
BAO - Existence,
completeness, valuation and
allocation
BAO - Valuation and
allocation
BAO - Existence,
Completeness, Rights and
obligations, Valuation and
allocation
BAO - Valuation and
allocation

Tests of accounting
estimates

14.

Review adequacy of clients


provision for uncollectible
accounts.
Examine certificates of title for
delivery equipment.
Confirm receivables.

15.

Trace bad-debt write-off

T of D of transactions

4.

8.

9.

10.
11.
12.
13.

T of D of balances

Initial procedures

BAO - Valuation and


allocation

T of D of disclosures

DAO Completeness,
Classification and
Understandability
BAO - Valuation and
allocation

T of D of
Balances
T of D of balance

BAO - Rights and obligations


BAO - Existence,
Completeness, Valuation and
allocation
TAO - Completeness,

16.
17.
18.

Audit Procedure
authorizations to accounts
receivable.
Observe clients inventory
taking.
Trace unpaid vendors invoices
to accounts payable at year-end.
Compare pension disclosures to
a disclosure check list.

Type of Test
T of D of balances
Test of details of
transactions
T of D of disclosures

Audit Objective
Accuracy
BAO - Existence,
Completeness,
TAO Completeness
DAO - Completeness of
presentation and disclosure,
Occurrence and rights and
obligations of disclosures

12-26. (Estimated time - 25 minutes)


1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

Assertion
BAO - Valuation or allocation
BAO - Completeness
BAO - Existence
BAO - Valuation or allocation
DAO Classification &
Understandability
BAO Existence
BAO Rights and obligations
DAO Classification &
Understandability
BAO - Completeness
BAO - Rights and obligations
BAO - Completeness
DAO Classification &
Understandability
BAO - Completeness
DAO Classification &
Understandability
BAO - Valuation or allocation

Substantive Test
C, J
A, B, E, F
C, D
I, K
L
A, B
A, B, E, H, I
M
B, E, H
E, H
F
L
E
L
I, K