Chapter 10

Substantive testing, computer

audit techniques and audit
programmes
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 table of contents

Case study
1 3
Substantive
Audit
testing
2 software
 table of contents
Subt. Audit

4 for wages
6
Directional Subt. Audit for
testing cash and bank
5 balances
 table of contents

7 Audit management
with the computer
Communication

8
 1

Substantive Testing of
Transactions, Account Balances
and Disclosures
Substantive procedure is
an audit procedure designed
to detect material
misstatements at the
assertion level. Substantive
procedures comprise:
● Test of details (of classes
of transactions, account
balances and
disclosures)
● Substantive analytical
procedures.
Test of controls is an
audit procedure
designed to evaluate
the operating
effectiveness of
controls in preventing,
or detecting and
correcting, material
misstatements at the
assertion level.
Two important reasons why substantive
tests should always be performed

Because the auditor’s There are inherent

assessment of risk is limitations to internal
judgemental and may control including
not be sufficiently management
precise to identify all override.
risks of material
misstatement.
 2
Case Study 10.1 Powerbase plc.: Reviewing audit programme
 Here are the following
substantive audit
programmes in the
purchases and trade
payables prepared by Bill
Chivers, junior member of
staff:

Purchases: interim audit Purchase daybook Purchase ledger Conclusion

Cheque payments. Select a. Select entries at a. Select a sample Note any conclusions
a sample of cheque random and of accounts and covering any
payments for purchases examine invoices test check the weaknesses and
of raw materials and and credit notes entries into the errors discovered
check as described below: for price, books of prime during the above tests
a. Agree to invoices for calculations and entry, checking for possible inclusion
goods received authorization, etc. the additions in a management
b. Agree to goods b. Check postings of and balances letter.
received notes entries to trade carried forward
c. Check calculations payables ledger. b. Enquire into all
and additions on contra items.
invoices
1.Check the sequence of 2. Check inventory 4. Check sequence of
purchase orders to records for accuracy by GRNs to ensure there are
ensure that there are no test counting quantities no breaks and trace a
breaks and trace a on hand and comparing random sample (say 20)
random selection of (say) with the records. to invoices, checking
20 of them to GRN, product description and
enquiring into any order quantities.
that has apparently not 3. Check a random
resulted in goods being selection of entries in the
received. inventory records (say 20)
to GRNs.
 3

The Use Of Audit Software

There are several different types of software
developed for use by the auditor including:

Generalized Statistical
audit software. 1 3 analysis software.

Software Expert system

developed for use in
2 4 software.
specific industries.
Generalized audit software and software developed for
specific industries
Generalized audit software and software developed for specific industries are
essentially interrogation tools used to access and examine data and
information held on file. Although they are designed primarily as tools for
testing to prove the validity and quality of data on file, they can also be used to
confirm that systems from which the data are derived and that development
and systems maintenance staff, including quality standards personnel, are
themselves of high quality.
What software can do :

- It can access files with many different characteristics and can

manipulate the data on them, for instance by sorting files and merging
different files.
- It can select data on the basis of predetermined criteria and can
perform arithmetical functions on data selected (such as: add, subtract,
multiply, divide).
- It can analyse selected data statistically and can stratify data into
desired categories.
- It can cause files to be created and updated from the company’s own
files.
- It can produce reports for the auditor in desired format.
Statistical analysis software
Generalized audit software can be used to select data on a statistically
sound basis. It might be used, for example, to select customers for
circularization, possibly stratifying the population of trade receivables
before making the selection. The software’s report writing facility
might be used to prepare summaries of customers selected and the
circularization forms to be sent to customers. The software might be
used to prepare a list of open items to be included on the forms.
The Use Of Computer-Assisted Audit Techniques (CAATs).

CAATs may enable more extensive testing of electronic

transactions and account files, which may be useful when the
auditor decides to modify the extent of testing, for example, in
responding to the risks of material misstatement due to fraud.
Such techniques can be used to select sample transactions from
key electronic files, to sort transactions with specific
characteristics, or to test an entire population instead of a
sample.
Examples Of Computer-Assisted Audit Techniques (CAATs)
Sales and trade receivables :

1. Listing large sales transactions for special investigation

2. Testing additions on invoices and trade receivable accounts.
3. Testing that sales have correctly entered the costing record.

Inventories and production cost.

4. Comparing finished inventory records with sales data.

5. Identifying abnormal usage or costs.
6. Testing overhead cost allocations
Examples Of Computer-Assisted Audit Techniques (CAATs)
Purchases and trade payables :

1. Listing large purchases of goods and services for later examination.

2. Analysing purchases of goods and services for each month or for the
year.
3. Listing details of new suppliers.

Investments :

4. Testing that income from all assets held is complete and accurate.
5. Listing changes in investment balance sheet values.
6. Comparing costs with investment market values.
Expert systems

Expert systems can be useful when a system or other area can be broken
down into a series of rules. Essentially, expert systems make expertise
available to persons who are not experts themselves. They are used both
for evidence collection and evaluation of the evidence, once collected.
For example :
- Is the company likely to face going-concern problems?
- Are any serious breaches in security likely?
- Appropriate audit programme steps after systems evaluation.
- Check legislation and accounting standards complied with.
4 Directional Testing
Auditors wish to prove that there are no material over- or
understatements in the financial statements. This means that
substantive procedures should be designed to test for such over-
or understatement, the auditor’s aim being clearly twofold in
nature. Many auditors suggest that the best way to achieve the
twofold aim is to direct tests of debit items (such as expenses,
cash receipts and assets) to detecting overstatement and to direct
tests for credit items (such as income, cash payments and
liabilities) to detecting understatement.
The objective of these tests is to ascertain that sales invoices
have been properly raised for all goods despatched. The
auditor would also test pricing and calculations. An important
point is that by testing debits (trade receivables) for
overstatement you are also confirming that sales are not
overstated, because of the nature of double entry.The
objective of the testing credits (in this case, trade payables) is
to check that there is no material understatement of
liabilities. The objective of testing debits (in this case,
purchases) is to ensure that there is no material
overstatement of purchase cost.
5
SUBSTANTIVE AUDIT
PROGRAMMES FOR
WAGES
Appendix 10.1 (TROSTON PLC)
This program incorporates tests of detail, but we draw your attention to the following paragraph
A7 of ISA 520 – Analytical procedures:

In some cases, even an unsophisticated predictive model may be effective as an analytical

procedure. For example, where an entity has a known number of employees at fixed rates of
pay throughout the period, it may be possible for the auditor to use this data to estimate the
total payroll costs for the period with a high degree of accuracy, thereby providing audit
evidence for a significant item in the financial statements and reducing the need to perform
tests of details on the payroll. The use of widely recognized trade ratios (such as profit margins
for different types of retail entities) can often be used effectively in substantive analytical
procedures to provide evidence to support the reasonableness of recorded amounts.

● The guided tests that must be included in the audit program are in principle as follows:
1. Testing to make sure there is nothing over the gross pay.
2. Testing to make sure nothing is underestimated from salary.
 Program objectives :
1. That financial accounting and costing records contain accurate,
complete and valid production wage records, including appropriate
allocations in the costing system for the cost of income, non-current
assets, and inventories.
2. That the money paid by the company for production wages and
related costs and described as such in financial accounting and
costing records reaches the persons intended for it.
3. That the wages paid have been paid for services performed for the
benefit of the company.
Audit Program
 IMPORTANT THING
A. Programs include program objectives, because it is
important for listeners to be constantly aware of what they
want to achieve. After establishing objectives, preparing an
audit program and conducting detailed tests in accordance
with the program, the auditor shall be able to draw
conclusions about the accuracy, completeness and
reliability of accounting records.
B. The auditor’s approach is dependent on the sophistication
of the computer system in place.
C. Regarding global tests, in preparing the audit program they have
assumed that the auditors would prepare statistical information but, if
this information is available in the company's computerized
information system, they might download it to their PC and review it
there.
D. The program refers to documents and records in existence in the
company (for instance, batch/equipment tickets) and reflects the
processing system in use, indicating that it has been tailor-made to the
organization.
E. Regarding level of testing, we decided to make your selection of
payrolls and employees.
F. Although many firms of auditors do not regard the wages
and salaries area as high risk in itself, production cost and its
relation to inventory appearing in the financial statements
may well be high risk and the auditor will normally wish to be
sure that labour costs have been properly determined.

G. Note in particular that the system is the one in operation

at the present time and not the system that may be in
existence in the future because of any recommendations the
auditor may care to make.
6
SUBSTANTIVE AUDIT
PROGRAMMES FOR CASH
AND BANK BALANCES
Audit measures are classified
under two broad headings:
■ Complete and accurate recording
Accommodation income. This revenue will be collected in cash
immediately or charged to the customer's account for
subsequent billing.

Program steps. Review the accommodation income work plan

and confirm that the auditor's work has enabled the auditor to
conclude that the income is genuine and is recorded
completely and accurately.
 ■ Proper safeguarding of cash
Tests conducted:

1. Check cash receipts and payment records for unusual

items and inquire about them.
2. Compare the total cash collected with the amount
recorded in the bank's entry book and bank statement.
3. Test the accuracy of individual cash receipts as recorded
by checking remittance suggestions, payment slips and
posting to customer accounts.
4. Banks no longer return checks to customers but on
occasion auditors may wish to obtain selected canceled
checks for audit purposes.
5. Banks no longer return checks to customers but on occasion
auditors may wish to obtain selected canceled checks for audit
purposes.

The canceled checks should be tested as follows:

➔ Check signatures on the checks to list of authorized

checks signatories. (This would highlight any apparently
unauthorized signing of checks.)
➔ Compare payees, amounts and dates to the cash book
and creditors ledger entries and other supporting
documentation.
6. A typical year-end verification test but can be performed on
an interim check as part of a program to check records and
keep cash satisfactory:

➔ Cash counting: given the large amount of cash, it is

necessary to arrange for sufficient audit firm staff to visit
the company at the same time so that no transfers can be
made between cash points to hide shortages.
➔ Confirmations from the bank's existing balances and
things like overdraft limits, accounts opened and closed
during the year, guarantees by and for third parties,
guarantees for overdrafts and so on.
7
Communication Of Audit
Matters
To TCWG (Management
Letter).
Communication Of Audit Matters
To TCWG (Management Letter).
■ One Objective Of Communicating To TCWG is:

To provide TCWG with timely observations arising

from the audit that are significant and relevant to
their responsibility to oversee the financial
reporting process.
Communication Of Audit Matters
To TCWG (Management Letter).

❏ The directors and others charged with governance

have duty to ensure internal controls are adequate
 MANAGEMENT
LETTER
● Management Letter has a title and
intended recipients clearly stated.

● The introduction explains why the

letter came to be written.

● Responsible officials with whom the

memorandum has been discussed.
 MANAGEMENT
LETTER
● If auditor no reason to doubt
integrity of officials, say so.

● A section stating the main

conclusions.
 MANAGEMEN
T LETTER
● The main conclusions are then
followed by detailed comments:
brief description, possible
consequences and
recommendations.
● Minor matters already cleared
with management should not
clutter the report.
● Auditors indicate willingness to
discuss matters at greater length
with TCWG and asks for a
response.
Further Matters Of Importance Relating
To The Management Letter.

1 2 3
May be circumstances where not Where small entities have Auditors report
appropriate to discuss findings insufficient staff for full weaknesses that have
direct with management, if segregation of duties – resulted or may result in
integrity or competence is in letter emphasizes misstatements in financial
question. importance of supervision statements.
by management.
Further Matters Of Importance Relating
To The Management Letter.

4 5
If no remedial action taken re Auditors of public sector
significant weaknesses in controls entities may have special
raised previously, current letter to responsibilities for
refer to it. Auditor to ask why no reporting internal control
remedial action taken. matters, e.g. compliance
with regulations of
legislative authorities.
 8

Audit management
with the computer
Audit Management With The
Computer.
Some ways in which audit automation is used:

■ Risk assessment, planning and allocation of staff and

other resources to the audit assignment
■ Information retrieval and analysis
■ Interpretation and documentation of results
■ Review and reporting activities
■ Manuals and checklists on computer file
Audit Management With The
Computer.
Two warnings:

1. Computer security applies equally to data held by

the auditor on computer file.
2. Spreadsheets can be an invaluable tool but their
preparation needs careful control.
THANKYOU!