REVISION

• CHAPTER 11 Slides
• Summary
• Revision question
Learning objectives
After studying this presentation, you should be able to:
11.1 describe how various risk factors relate to the type of
potential misstatement
11.2 explain the process for determining the appropriate
level of substantive procedures based on the
assessment of detection risk, inherent risk and control risk
11.3 explain how the auditor designs substantive
procedures for each audit and uses the nature, timing
and extent of substantive procedures to achieve an
acceptable level of detection risk
Learning objectives

11.4 describe and apply a general framework for

developing audit programs for substantive procedures and
explain which substantive procedures may normally be
included in an audit program
11.5 understand special considerations when designing
substantive procedures.
Introduction
• In the previous chapter we discussed how the auditor needs to obtain sufficient
understanding of the entity and its environment, including its internal controls, to
identify and assess the risks of material misstatement of the financial statements.
• We also previously considered how the auditor might use the audit risk model as a
framework to respond to the assessed risks of material misstatements and how
these are connected to the concept of audit evidence.
• We considered how the auditor might obtain audit evidence by relying on and
testing an entity’s internal controls.
• This chapter explains how the assessment of the risk of material misstatement
affects the required level of detection risk, which will affect the design of
substantive procedures.
• The acceptable level of detection risk influences the assessment of the nature,
timing and extent of the procedures that need to be performed to gain sufficient
appropriate audit evidence to substantiate the earnings and expenditure figures,
and the values in the balance sheet.
LO 1 – Assessing the risk of
material misstatement
• Describe how various risk factors relate to the type of
potential misstatement.
• To perform the appropriate substantive procedures, the auditor
must carefully assess the risk of material misstatement from the
knowledge obtained in gaining an understanding of the entity and
its environment
The type of potential
misstatement
• Audit process involves recognising risk factors
• Linking those factors to assertions that are likely to be misstated
• Risk factors can affect the potential for misstatements in
the financial statements in two ways:
– Some risk have a pervasive effect on the financial
statements and influence multiple account balances and
assertions (financial statement level risks)
– Other risk factors are assertion-specific (assertion level
risks).
The magnitude of potential
misstatements
• Some potential misstatements are more significant than
others.
• Audit time and resources are limited.
• Auditors need to allocate more audit attention to the
assertions that can have a potential material effect:
• Individually or in aggregate on the financial statements.
The likelihood of material
misstatement
• Auditor identifies various business risks, inherent risks, and
fraud risks that might affect the financial statements
• Auditor should consider the adequacy of the system of
internal controls
• The greater the effectiveness of controls a company puts in
place, the less the likelihood of material misstatement
• Auditor needs to test controls they rely upon
• The higher the likelihood of material misstatement, the
more the auditor should respond with substantive tests to
obtain reasonable assurance that material misstatements
can be detected and corrected
LO.2 - Determining detection risk
• Explain the process for determining the appropriate level
of substantive procedures based on the assessment of
detection risk, inherent risk and control risk.
• Detection Risk (DR) is the risk that the auditor’s substantive
procedures will not detect a material misstatement
• The relationship between detection risk, inherent risk and control
risk can be expressed by the audit risk model, as represented in
the equation:
• AR = IR × CR × DR
• For a given level of Audit Risk (AR) specified by the auditor, DR is
inversely related to the assessed levels of Inherent Risk (IR) and
Control Risk (CR)
Predominantly substantive
approach
• Auditor may assess control risk as being high and adopt
the predominantly substantive approach when:
• There are no significant control procedures that relate to the
assertion
• Any relevant control procedures are unlikely to be effective.
• Costs of performing the higher level of substantive procedures are less
than the combined costs of performing sufficient tests of controls to
support a lower assessed level of control risk approach.
LO.3 - Designing substantive
procedures
• Explain how the auditor designs substantive procedures for each
audit and uses the nature, timing and extent of substantive
procedures to achieve an acceptable level of detection risk.
• Substantive tests are procedures that:
• provide evidence which supports the fairness of each of management’s
financial statement assertions
• reveal monetary errors or misstatements in recording or reporting of
transactions and balances.

• Refer ASA 330 The Auditor’s Responses to Assessed Risks

• The auditor shall design and perform further audit procedures whose nature,
timing, and extent are based on and are responsive to the assessed risks of
material misstatement at the assertion level.
Nature of substantive procedures
• Nature refers to type and effectiveness of audit procedures
to be performed
• If the assessed detection risk is low, the auditor would need
to use more effective and more costly procedures
• If the assessed detection risk is high, the auditor can use less
effective and less costly procedures
• Types of substantive procedures are:
• Analytical procedures
• Tests of details of transactions
• Tests of details of balances.
Tests of details of transactions –
tracing
Mainly involves tracing and vouching

SUPPORTING/
ACCOUNTING
SOURCE TRACING
DOCUMENT BOOKS
e.g. Remittance (risk of e.g. Cash
advices understatement) Receipts Journal
Tests of details of transactions –
vouching
Mainly involves tracing and vouching

SUPPORTING/ ACCOUNTING
SOURCE VOUCHING
DOCUMENT BOOKS
(risk of e.g. Purchases
e.g. Supplier
overstatement)
Invoice Journal
Tests of details of balances
• Focuses on obtaining evidence directly about an ending
account balance
• Effectiveness of these tests depends on the particular
procedure performed and type of evidence obtained

• Main way of collecting evidence for the balances that make

up the balance sheet
LO. 4 Framework for developing
audit programs
• Describe and apply a general framework for developing audit
programs for substantive procedures and explain which substantive
procedures may normally be included in an audit program.
• An audit program is a list of auditing steps to be performed
• A framework for developing audit programs for substantive
procedures includes:
• Complete preliminary planning such as:
• Develop specific audit objectives for each assertion relating
to closing balances
• Assess inherent and control risk
• Consider options regarding the design of SPs
• Consider whether it is effective and efficient to use CAATs.
• Specify substantive procedures to be included in audit program.
Audit programs in initial
engagements
• ASA 510 Initial Audit Engagements – Opening Balances
identifies 2 matters for special consideration:
• Whether opening balances contain misstatements that
materially affect the current period’s financial report.
• Whether appropriate accounting policies reflected in the
opening balances have been consistently applied in the current
period’s financial report, or changes in policies are
appropriately accounted for an adequately presented, and
disclose in accordance with the applicable financial reporting
framework.
LO.5 - Special considerations when
designing substantive procedures
Understand special considerations when designing
substantive procedures.
• Income statement accounts
• Accounting estimates including fair value
• Related parties
• Inventory and segment information
• External confirmations.
Income statement accounts
• Tests of details of balances focus more on financial
statement assertions that refer to balance sheet accounts
than on income statement accounts
• Each income statement account is inextricably linked to
one or more balance sheet accounts
• Evidence obtained through substantive procedures
applied to balance sheet accounts provides evidence for
income statement balances
• Thus, analytical procedures are often all that is needed.
 CHAPTER SUMMARY
• After assessing the risk of material misstatement, the auditor must assess how to reduce that risk to
an acceptable level by performance of control tests and/or substantive procedures.
• This chapter focuses on the company’s response to the risk of material misstatements through the
design of substantive procedures (i.e. a predominantly substantive audit approach).
• The acceptable level of detection risk and level of substantive procedures are usually determined by consideration
of the audit risk model.
• The auditor then plans specific substantive procedures to achieve the acceptable level of detection risk by
exercising judgements about the nature, timing and extent of such procedures.
• The auditor also relates the tests to specific audit objectives, to ensure that the overall objective of rendering an
opinion on the financial statements as a whole is met.
• The auditor’s decisions about the design of substantive procedures are documented in the form of written audit
programs, which provide an outline of the work to be done and a way of controlling the audit and recording the
work performed.
• A general framework may be used in developing effective and efficient audit programs for substantive procedures
tailored to the entity’s circumstances.
• There are special considerations in designing substantive procedures for selected types of accounts, including profit
and loss accounts, accounting estimates and related parties.
• Ultimately, for most audits, the performance of these substantive tests will constitute a large part of the audit
evidence that the auditor uses to form an opinion on the financial statements.
 Revision Question
Q. What factors should be considered when the auditor attempts to coordinate his or her work with
the entity’s internal auditors?
•  Answer the specifics of the question
• The factor to be considered..
• The auditor must first consider the effectiveness of the internal auditors
How?
• By:
• considering (you are taking something into consideration in view of ) their organisational status;
• determining (causing something to be done in a particular way) the scope of their work and, in particular,
whether management acts on their recommendations;
• evaluating (forming an idea of the value of something) their technical competence; and
• ensuring (making sure that something will be done) that their work is performed with due professional care.
• 
• When the external auditor intends to use the specific work of internal audit, the external auditor
shall evaluate and perform audit procedures on that work to confirm its adequacy for the external
auditor’s purposes.