Substantive Procedures the Concepts

Why do we perform substantive testing on an audit?

The objective of substantive testing is to reduce the auditor’s detection risk to an acceptable level.

Substantive procedures are performed to obtain evidence to assess whether the amounts and
disclosures in the financial statements are free from material misstatements.

Substantive procedures include

 Tests of detail of transactions and balances; and

 Analytical procedures

Per ISA 330.6 and 315.5 the auditor should design further audit procedures whose nature, timing and
extent are responsive to the assessed risks of material misstatement at assertion level.

Categories of substantive tests:

1. Re-performance: The auditor will repeat, either wholly or in part, the same procedures as those
previously performed by the client.
2. Recalculation: Involves checks carried out by the auditor, on the arithmetical accuracy of source
documents and accounting records, or includes calculations performed independently by the
auditor.
3. Inspection: Inspection of records, documents and/or tangible assets by the auditor.
4. Analytical Procedures: Analysis, by the auditor, of significant ratios and trends and includes the
resulting investigation of fluctuations and relationships that are inconsistent with other relevant
information or they deviate from predicted amounts.
5. Enquiry and Confirmation: These are performed by the auditor. Intention is to obtain
information from knowledgeable individuals inside or outside the entity. Enquiries range from
written enquiries addressed to third parties, to informal verbal enquiries addressed to
individuals within the entity. Responses to enquiries provide the auditor with information not
previously possessed or with corroborative audit evidence (confirms something you already
know).
Confirmation consists of the response to an enquiry made to corroborate information in the
accounting records, e.g. the auditor obtaining direct confirmation of bank balances by
communicating with the bank.
6. Observation: Looking at a process or procedures being performed by others.

Financial Statement Assertions:

The objective of an audit is for the auditor to express an opinion on whether the financial statements
are fairly presented.

The financial statements are nothing more than an embodiment, in a prescribed format, of the
assertions of the directors to the shareholders concerning the financial position and results of
operations of the company they are managing on behalf of those shareholders.

Per ISA 315 the assertions are categorized as follows:

Open Rubric
Assertions related to classes of transactions and events for the period under audit per ISA 315 paragraph
A129 (a):

1. Occurrence – Transactions and events that have been recorded or disclosed, have occurred, and
such transactions and events pertain to the entity.
2. Completeness – All transactions and events that should have been recorded have been
recorded, and all related disclosures that should have been included in the financial statements
have been included
3. Accuracy – Amounts and other data relating to recorded transactions and events have been
recorded appropriately and related disclosures have been appropriately measured and
described
4. Cut Off – Transactions and events have been recorded in the correct accounting period
5. Classification – transactions and events have been recorded in the correct accounts
6. Presentation – transactions and events are appropriately aggregated or disaggregated and
clearly described, and related disclosures are relevant and understandable in the context of the
requirements of the applicable financial reporting framework

Assertions related to account balances at period end per ISA 315 paragraph A129 (b):

1. Existence – Assets, liabilities and equity interest exist

2. Rights and Obligations – The entity holds or controls the rights to assets and liabilities are the
obligations of the entity
3. Completeness – All assets, liabilities and equity interests that should have been recorded have
been recorded, and all related disclosures that should have been included in the financial
statements have been included
4. Accuracy, Valuation and Allocation – Assets, liabilities and equity interests are included in the
financial statements at appropriate amounts and any resulting valuation or allocation
adjustments are appropriately recorded, and related disclosures have been appropriately
measured and described
5. Presentation – assets, liabilities and equity interests are appropriately aggregated or
disaggregated and clearly described, and related disclosures are relevant and understandable in
the context of the requirements of the applicable financial reporting framework

Scrutiny of the assertions described above will indicate that some assertions apply to assets and
liabilities only, whilst others apply to transactions/events and two assertions apply to assets, liabilities
and transactions/events.
The below table illustrates this:

Assertion Transactions/Events Balances (A, L & E)

Occurrence X
Completeness X X
Accuracy X X
Cut Off X
Classification X
Existence X
Rights and Obligations X
Valuation and Allocation X
Presentation X X

Example 1:

When an auditor gathers evidence about sales transactions he/she will be seeking evidence to support
the following assertions:

Completeness – All sales which were made have been included in the total of sales made for the year

Occurrence – All sales included are genuine sales of the entity

Accuracy – All sales have been recorded appropriately

Cut Off – All sales recorded occurred in the accounting period being audited

Classification – All sales have been posted to the proper account

Presentation – All sales have been appropriately disclosed and clearly described

Note: The auditor will also ensure that disclosures pertaining to sales are complete, appropriately
classified and accurate

Example 2:

When the auditor gathers evidence about fixed assets he or she will be seeking evidence to support the
following assertions:

Completeness – All fixed assets owned by the company are included in the balance reflected in the
financial statements

Existence – All fixed assets existed at balance sheet date

Valuation and Allocation – The fixed assets have been reflected in the balance sheet at an appropriate
carrying value. This means that reasonable adjustments have been made for depreciation and/or
obsolescence

Rights – The Company has right of ownership to the fixed assets reflected in the balance sheet and any
encumbrances on that ownership must be disclosed

Note: The auditor will also need to address all the assertions pertaining to presentation and disclosure
Question? – The Occurrence assertion does not apply to fixed assets. Why? It is because this assertion
applies only to transactions/events and not to balances contained in the statement of financial position.
The auditor seeks to establish that a fixed asset appearing on the statement of financial position actually
existed at period end. Auditing the purchase of the fixed asset (a transaction) will provide evidence that
the purchase occurred and was accurately recorded but it will not provide evidence that the fixed asset
was in existence at year end (it may have been sold, destroyed or stolen), or that it was fairly valued (it
may have been severely damaged since it was purchased).

Examples of substantive audit procedures of obtaining evidence by using WHAT, HOW,WHY:

Account Balances

Existence:

 WHAT: Attend the stock count

HOW: by confirming date, time and locations with client
WHY: to confirm that the stock exists

 WHAT: Physically inspect fixed assets

HOW: selected from the fixed asset register
WHY: to confirm the assets exist

 WHAT: If physical inspection is not possible

HOW: request and inspect the client’s insurance portfolio and insurance valuation report
WHY: to confirm that the assets are there and exist

Rights/Obligations:

 WHAT: Inspect title deeds

HOW: for the name of the title holder
WHY: to confirm that the client has a right over the asset (these belong to the client)

 WHAT: Inspect licenses and registration documents

HOW: for the name of the owner
WHY: to confirm that these do belong to the client

 WHAT: Inspect insurance portfolio

HOW: to note the name of the insurance holder
WHY: to confirm that the client has the rights over the asset (they belong to the client)

Completeness

 WHAT: Select invoices at year end

HOW: and trace to creditors listing
WHY: to ensure all creditors are recorded
Valuation

 WHAT: Inspect valuer’s report

HOW: for the valuation amounts
WHY: to confirm that the assets are appropriately valued

 WHAT: Compare cost prices on stock sheets

HOW: with prices on suppliers’ invoices/price lists
WHY: to confirm that stock is appropriately valued

Classes of transactions

Accuracy

 WHAT: Recalculate supplier’s invoice

HOW: by casting and cross casting
WHY: to confirm arithmetical accuracy

 WHAT: Compare the cost of the property

HOW: with the purchase agreement and the statement from the attorney
WHY: to verify the cost of acquisition and transfer of the property

Occurrence

 WHAT: Scrutinize the repairs and maintenance expense account

HOW: by going through the expense ledger accounts in detail
WHY: to confirm that no capital items were included here

Cut Off

 WHAT: Note the last delivery note number for the year
HOW: by obtaining this from the client
WHY: to confirm these were recorded in the correct period

 WHAT: Confirm by means of inspection that the 10 delivery notes before the last number are
included in the current year’s sales journal
HOW: by obtaining the last 10 delivery notes from the client
WHY: to ensure that they were recorded in the correct period

 WHAT: Confirm by means of inspection that the 10 delivery notes after the last number are
excluded from the current year’s sales journal
HOW: through sequence checks
WHY: to ensure that they were recorded in the correct period
Completeness

 WHAT: Trace sales transactions

HOW: from the goods delivery notes to the sales invoices/sales journal
WHY: to confirm that all sales transactions have been included

The direction of testing substantive procedures is an important consideration:

 Accounts like debtors (assets) and expenses are tested for overstatement. The direction of
testing is from the accounting records to the source documents as the temptation is to
overstate assets values, overstate expenses and therefore understate taxation
 Accounts like creditors (liabilities) and income and reserves are tested for understatement. The
direction of testing is from the source documents to the accounting records as the temptation is
to overstate asset values and therefore understatement of taxation.

Suggestions on how to answer a substantive procedure question

Substantive questions may require candidates to describe audit procedures to:

 Vouch transactions; and/or

 Verify valances at a certain

Determine stage of the audit the question is directed at (interim and/or year-end)

Be practical in our answers

Include the standard general procedures:

 Re-performance of calculations
 Arithmetical accuracy/cast, cross cast
 Obtain written representation from management.
 Analytical procedures
 Comparing GL to TB to AFS
 Disclosure on AFS

When verification procedures are required it is not sufficient to state as a procedure – perform cut off
tests. You have to describe in detail the cut off procedure you will perform e.g. select the last 10 sales
invoices for the year and confirm through inspection that the dates are in the current year and
recognised as sales in the current year.

Example on Purchases Cut Off Procedures

 Note number of last goods received voucher (GRV) for the year
 Confirm by means of inspection that the 10 GRV’s before the last number are included in the
current year’s purchases journal
 Confirm by means of inspection that the 10 GRV’s before the last number are not included in the
current year’s purchases journal.
Example on Sales Cut Off Procedures

 Note the last delivery note number for the year

 Confirm by means of inspection that the 10 delivery notes before the last number are included
in the current year’s sale journal
 Confirm by means of inspection that the 10 delivery notes before the last number are included
in the current year’s sale journal
 Confirm by means of inspection that the 10 delivery notes after the last number are not
included in the current year’s sale journal

If a question specifically requires you to deal with disclosure requirements you should provide all the
details as per the IAS and IFRS standards. Otherwise a general statement of “Inspect the financial
statements and accounting policies and confirm they are in compliance with IFRS will suffice”.

When amounts/figures are provided in a question, always use them in your answer – incorporate them
as part of the procedure

Never forget “Analytical Review” procedures. These are an important source of audit evidence as a
substantive procedure and can often be used in a substantive verification procedure question. Also
remember there may be questions that specifically state “no analytical review procedures are required,”
in this instance you do not need to add these in:

 Current balance can be compared to prior year (name the balance e.g. Debtors balance)
 Current balance can be compared to budgets (name the balance e.g. Debtors balance)
 Monthly fluctuations can be analyzed (e.g. sales fluctuations)
 Current ratios can be compared to prior tear/month (name the ratio e.g. debtors days
outstanding)
 Current ratios can be compared to budgets month (name the ratio e.g. debtors days
outstanding)
 Also state that unexpected fluctuations/ratios will be followed up with management to obtain
explanations

When procedures (these are actions) are required, you should list exactly what you are going to do, not
what you will “consider” doing

Develop audit procedures while you are studying Companies Act. King IV, Financial Accounting etc.

 Visualize and note the accounting entries/requirements relevant to the transaction given in the
description
 Note, for amounts, how they are calculated and the relevant accounting entries
 Identify sources of evidence underlying the given transactions/balances
 Develop appropriate audit procedures by taking into account the accounting entries and the
sources of audit evidence available

Avoid meaningless statements, statements such as:

 Ensure
 Check
  Verify
 See/look
 Confirm
 Consider
 Determine
 Assess

In your answers because they usually don’t describe audit procedures but audit objectives

If you are required to describe audit procedures, you should describe them as you would to a first year
trainee accountant e.g. if you tell him/her to “check the ownership of the motor vehicle” he/she would
not know what procedure to perform. You have to explain in detail, “Inspect the registration documents
and licences and confirm that the vehicle is registered in the client’s name”

Always identify the source documents, i.e. reconcile creditor’s balance with the creditor’s monthly
statement and goods received notes

General Audit Procedures

 Test castings and calculations of general ledger, afs, documentary evidence (list/schedule etc.),
reconciliations
 Agree opening balance with prior year working paper
 Test posting from subsidiary ledgers to the general ledger
 Agree total of lists to the general ledger accounts
 Agree total on general ledger to the trial balance and annual financial statements
 Inspect minutes of management/board of directors and shreholders for decisions taken and
authorisations
 Perform analytical procedure – give details and example of the procedures
 If accounting treatment related question then refer to the IFRS standard to note recognition
criteria and formulate procedures to address/assess these
 Request written representation letter from management.
 Request attorneys confirmation/letter (where applicable)
 Overall review for abnormal/unusual items/exceptions e.g. review general ledger account for
any unsual entries. Inspect for credit entries on dr accounts etc.
 Inspect annual financial statements for disclosure of item and relevant accounting policy is in
compliance with IFRS requirements