SOLUTIONS

HOMEWORK SOLUTIONS

9.1 The best way to explain the differences between substantive tests and tests of controls is to consider the
objectives of the different types of testing.

The auditor’s main objective in undertaking tests of controls is to support their initial assessment of
control risk. Tests of controls provide evidence that controls are functioning effectively throughout the
period of the auditor’s intended reliance.

In undertaking substantive tests, the auditor wants to substantially verify the dollar value of the
transactions or balances (that is, identify whether monetary errors have occurred). The auditor undertakes
substantive testing to reduce their detection risk.

Implicit in the above discussion is that when undertaking tests of controls the auditor is not interested in
dollars, just whether the control of interest has operated as expected. When undertaking substantive tests,
the auditor is interested in the dollar amount of the transaction or balance.

9.2 The difference between substantive tests of transactions and substantive tests of balances is explained in
Global Example 9.1 of the text. For example, the accounts receivable balance at the end of the year
comprises a number of transactions, sales and cash receipts from the perspective of the audit client. If the
auditor undertakes testing of the balance, which is the aggregate of a number of transactions (such as by
a debtor’s confirmation), then they are undertaking substantive testing of balances. If they test the dollar
value of the individual transactions that make up the balance, such as by vouching each individual
transaction to supporting documentation, or vouching a sample of those transactions, then they are
undertaking substantive testing of transactions.

9.4 Evidence obtained directly from the bank is more reliable than a copy of the bank statement obtained
from the client, as the client has had the opportunity to manipulate the bank statement. Also, the bank
confirmation will provide other information besides the balance, such as other accounts held at the bank,
securities held by the bank and financial instruments.

9.6 The auditor should attend the physical inventory counting, unless impracticable, to:

 evaluate management’s instructions and procedures for recording and controlling the results of
the entity’s physical inventory counting

 observe the performance of management’s count procedures

 identify inventory that looks obsolete (e.g. dust on packaging) or damaged while undertaking a
general walkaround of the inventory holding area

 perform test counts from recorded amount to inventory on shelves (existence)

 inspect the condition of the inventory when test counting.

9.7 The auditor’s primary concern in tests of balances for liabilities is normally the completeness assertion.
The auditor is most concerned about the possibility of unrecorded liabilities, because there is usually a
greater risk of understatement of liabilities than of overstatement. Understatement of liabilities is
associated with an understatement of related expenses, and therefore an overstatement of profit and
owner’s equity. The most common way of understating liabilities is not including them, leading to
completeness being the major assertion at risk.

9.14

As per ASA 330 (ISA 330), the auditor’s general approach can be either to adopt an emphasis on
substantive procedures (substantive approach) or to use tests of controls as well as substantive procedures
(combined approach).
The background information provided suggests that a substantive approach would be the most
appropriate. It appears likely that there are very few control activities relevant to the audit assertions, and
that it is unlikely that any control activities would be effective due to the lack of segregation of duties and
the lack of owner involvement in controls in the small business. Due to the lack of controls, these
substantive tests will primarily be tests of detail, as limited reliance can be placed on substantive
analytical procedures when controls are not reliable.
ADDITIONAL QUESTION

9.24

(a) Reason (b) Assertion Explanation (c) Substantive test of detail

accounts payable most at risk
is at risk
A large portion of Accuracy, Foreign accounts Select a sample of overseas
accounts payable valuation and payable are required to accounts payable from the
is represented by allocation be translated at the overseas accounts payable
overseas accounts closing exchange rate ledger and check that the
payable paid in at balance date, leading liability in foreign currency has
foreign currency to the risk of error in been translated using the
using an incorrect rate closing exchange rate at
balance date
Asian Foods Completeness Asian Foods takes  Select a sample of supplier
accepts liability ownership of overseas invoices/shipping
for goods upon shipments upon their documents in respect of
the goods being being loaded onto the shipments received after
loaded onto the ship. Accordingly, balance date and determine
ship there is a risk that when the goods were
shipments loaded prior loaded. If they were loaded
to balance date and prior to balance date,
received thereafter may ensure that they have been
not have been recorded recorded in accounts
as a liability at balance payable at balance date.
date.
 Select a sample of supplier
payments made after
balance date and check
against relevant supplier
invoicing/shipping
documents. If the goods
were loaded before balance
date, ensure that they have
been recorded in accounts
payable at balance date.