AUDITOR’S
RESPONSE TO ASSESSED RISK
OUTLINE Introduction The Basis of Evidence Financial Statement Assertions Test of Controls
Substantive Procedures
THE BASIS OF EVIDENCE
THE BASIS OF EVIDENCE Evidence is anything that can make a preson believe that a fact, proposition or assertion is true or false. Audit evidence is information used by the auditor in arriving at the conclusion on which the auditor’s opinion is based. Audit evidence is different from the legal evidence required by forensic accounting.
THE BASIS OF EVIDENCE Evidence for proof of audit is different from evidence in legal sense. Audit evidence needs only to prove reasonable assurance, whereas in a legal environment there is a more rigorous standard of proof and documentation.
Electronic Evidence Some of the entity’s accounting data and other information may be available only in electronic form. For example, entities may use electronic data interchange (EDI) or image processing systems. The elctronic nature of the accounting documentation usually requires that the auditor use computer-assisted audit techniques (CAATs)
FINANCIAL STATEMENT ASSERTIONS
FINANCIAL STATEMENT ASSERTIONS Management is responsible for the fair presentation of financial statements so that they reflect the nature and operations of the company based on the applicable financial reporting framework (IAS, GAAP, etc). ▪
In representing that the financial statements are in accordance with the applicable financial reporting framework, management implicity or explicity makes assertions regarding the recognition, measurement, presentation and disclosure of the various elements of financial statements and related disclosures. ▪
Management makes assertions that can be grouped into the three groups (see the picture) Assertions are representations by management, explicit or otherwise, that are embodied in the financial statements, as used by the auditor to consider the different types of potential misstatements that may occur. The auditor assesses risks of potential misstatements based on these assertions and designs audit procedures to discover sufficient approprate evidence. Auditor evidence comprises both information that supports and corroborates management’s assertions, and any information that contradicts such ▪
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SUBSTANTIVE PROCEDURES
SUBSTANTIVE PROCEDURES The main work of an auditor is to find evidence using test procedures A substantive procedure designed to detect material misstatements at the assertion level. Substatntive procedures comprise: Test of details (of classes of transactions, account balances and disclosures); Substantive analytical procedures
SUBSTANTIVE PROCEDURES Substantive procedures are responses to the ▪
auditor’s assessment of the
risk of material misstatement. The higher the assessed risk, the more likely the extent of the substantive procedures will increase and the timing of procedures will be performed close to the period. ▪
Irrespective of the assessed risks of material misstatement, the auditor should design and perform substantive procedures for all relevant assertions related to each material class of transactions, account balance and disclosure. Furthermore, if the auditor has determined that an assessed risk of material misstatement at the assertion level is a significant risk, the auditor should perform substantive procedures that are specifically responsive to that risk. ▪
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SUBSTANTIVE PROCEDURES Nature of Substantive Procedures
The nature of substantive procedures includes tests of details (of transactions and of balances) and substantive analytical procedures. The auditor’s substantive procedures include agreeing the financial statements to the accounting records, examining material adjustments made during the coutse of preparing the financial statements, and other procedures relating to the financial reporting closing process. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time.
SUBSTANTIVE PROCEDURES Tests of Balances Test of balances are substantive tests that provide either reasonable assurance of the validity of a general ledger balance or identify a misstatement in the account. Test of balances are important beacuse the auditor’s ultimate objective is to express an opinion on financial statements that are made up of account balances.
SUBSTANTIVE PROCEDURES Illustration-Test of Accounts Receivable Balance If accounts receivable total $1,500,000 at the end of the year, tests of details may be made of the individual components of the total account. Assume that the accounts receivable control account balance of $1,500,000 is the total of 300 individual customer accounts. As a test of balances, an auditor might decide to confirm a sample of these 300 accounts. Based on an analysis of internal controls, the auditor may decide that the proper sample size should be 100 accounts that should be tested by confirmation.
SUBSTANTIVE PROCEDURES Test of A/R = Test of Revenue From the auditor’s perspective, this means that a test of one side of the transaction simultaneously tests the other side of the transaction
SUBSTANTIVE PROCEDURES Direction of Testing Testing for overstatement or understatement is called the direction of testing.
Interim Testing Using Substantive Procedures There are several considerations in determining the timing of substantive procedures. In some instances, primarily as a practical matter, substantive procedures may be performed at an interim date. Peforming audit procedures at an interim date may assist the auditor in identifying and resolving issues at an early stage of the audit.
SUBSTANTIVE PROCEDURES Extent of Substantive Procedures
The greater the risk of material misstatement, the greater the extent of substantive procedures. In planning tests of details of transaction or balances, the extent of testing is ordinarily thought of in terms of the sample size, which is affected by the risk of material misstatement. The use of CAATs may enable more extensive testing of electronic transactions and files.
SUBSTANTIVE PROCEDURES Test of Details: Search for Unrecorded Liabilites
A substantive test usually performed on A/P is a search for unrecorded liabilities. To search for unrecorded liabilities, the auditor reviews disbursements made by the client for a period after the balance sheet date, sometimes to the date of the completion of field work. Even though a client may not record accounts payable at year-end, vendors will probably pressure the client to pay the accounts payable within a reasonable period of time. Due to this pressure, most unrecorded accounts payable are paid within a reasonable time after the balance sheet date.
SUBSTANTIVE PROCEDURES Test of Details: Search for Unrecorded Liabilites
Procedures to find unrecorded liabilities start with a review of the cash disbursements journal for the period after the balance sheet date. The auditor then vouches a sample of invoices to determine to which period the payment relates.
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