Substantive Audit Procedures Types Examples

Substantive Procedures in Auditing: Definition & Explanation

Review PPE purchasing documents like internal requisition, quotation approved, capital budget, purchase order, goods receipt note, and payment to ensure the recorded purchase is free from material misstatement. Observation of inventory is a generally accepted auditing procedure, where an independent auditor issues an opinion on whether the financial records of inventory accurately represent the physical inventory being carried. Designed to reveal material misstatements at the assertion level.

  • In this case, tests of details are the audit procedures that auditors perform to test various audit assertions of significant account balances, classes of transactions, and disclosures of the client’s financial statements.
  • It provides evidence that the balance of accounts payable is correct and complete.
  • Here, we perform testing by verifying all the underlying supports.
  • Benefits Effective data management offers several advantages to organizations.

For example, let’s consider a kiosk in the mall that sells smartphone cases. They might report on their financial statements that they have $30,000 in inventory. To confirm that, the auditor would look at the inventory records and ensure that the value of each item was accurate and that the quantity and value of all the different products added up to $30,000. They might even select a sample of products and physically count the products to ensure the inventory ledger agrees with the actual physical count.

What is Internal Audit Department? (Responsibilities and More)

Or, if an increase in cost of sales in one month was attributed to an unusually large sales contract, the auditor might examine supporting documentation, such as the sales contract and delivery dockets. When using analytical procedures, it’s critical for the auditor to establish a threshold that can be accepted without further investigation. This threshold is influenced primarily by the concept of materiality and the desired level of assurance. The threshold is typically lower when using analytics to perform substantive testing than when using analytics in planning or final review.

Here, Banks, Financial Institutions, and Debtors are examples of the third party confirmations . The significant risks relatable to revenue are overstatement to build up a higher-profits and establish the Company as good performing.

Developing Audit Programs for Substantive Tests

If you are testing controls for effectiveness, you may want to do so before creating any related substantive analytics. Document a sufficiently Substantive Procedures in Auditing: Definition & Explanation precise expected result of the computation or comparison. Document the expectation prior to examining the recorded numbers.

Substantive Procedures in Auditing: Definition & Explanation

With this type of audit process, auditors usually try to confirm that existing business procedures or measures are being implemented by the organization. This type of procedure gives auditors an idea on how internal processes work, and if they can affect the operations of the organization as a whole. While the substantive method uses apparent proofs as an audit basis, analytical methods take this a step further. Analytical methods pair financial data with non-financial data and determine the correlation between them. Comparison of previous trends vs current trends, as well as evaluation of the difference between the client’s record and the substantive evidence, are also considered analytical methods. An understanding of the purposes of analytical procedures and the limitations of those procedures is also important. Conversely, tests may reveal monetary errors or misstatements in the recording or reporting transactions and balances.

Importance of Auditing Inventory

It’s a procedure that seeks explanation/information from the management. For instance, during an audit, you notice marketing expense has increased in comparison to last year. So, you decide to approach management and seek their explanation. So, observation helps auditors to assess if the client is committed to the internal controls. Further, auditors can develop point estimates based on observation and compare them with the reported figures.

  • These transactions concern the auditor because they may not be executed on an arms-length basis.
  • Examples of data that auditors use to develop their expectations include prior-period information , management’s budgets or forecasts, and ratios published in trade journals.
  • There are two types of substantive procedures which are substantive analytical procedures and tests of details.
  • Evidence is required by auditors to verify the validity of financial records.
  • For some assertions, analytical procedures are effective in providing the appropriate level of assurance.

It comes from my YouTube playlist Audit Risk Assessment Made Easy. In control testing, the auditor wants to assess the internal control designed and implemented by the auditor especially the internal control over financial reporting. Monthly amounts will generally be more effective than annual amounts and comparisons by location or line of business usually will be more effective than company-wide comparisons. The level of detail that is appropriate will be influenced by the nature of the client, its size and its complexity. Generally, the risk that material misstatement could be obscured by offsetting factors increases as a client’s operations become more complex and more diversified.

Here, we perform testing by verifying all the underlying supports. Freight cost analysis includes determining the shipping or freight costs for transporting inventory to different locations. Generally, freight costs are included in the value of inventory, so it is important to track the freight costs as well. The cut-off analysis includes pausing operations such as receiving and shipping of inventory while making a physical count to avoid mistakes. An ABC analysis includes grouping different value and volume inventory. For example, high-value inventory, mid-value, and low-value products can be grouped separately. The items can be tracked and stored in their separate value groups as well.

  • Substantive procedures in auditing are performed in order to verify an assessment about some aspect of an organization.
  • This process helps auditors check for the occurrence of specific transactions or events.
  • An inventory audit can be as simple as just taking a physical count of stock and inventory to verify a match to the accounting records.
  • Substantive procedures are designed to obtain audit evidence regarding the completeness, accuracy, and validity of data produced by the accounting system.
  • Let’s say, “ASAP” Company has debtors‘ balances of $568,000 as of year-end.
  • Audit standards tell us that substantive analytics are more appropriate when the risk of misstatement is lower.
  • Auditors must decide when it is most appropriate to use which type of substantive procedures.

Relationships in a stable environment are usually more predictable than relationships in a dynamic or unstable environment. Relationships involving transactions subject to management discretion are sometimes less predictable. For example, management may elect to incur maintenance expense rather than replace plant and equipment, or they may delay advertising expenditures. In some cases, analytical procedures can be more effective or efficient than tests of details for achieving particular substantive testing objectives.

Substantive analytical procedures are usually performed when the risk of material misstatement is low and there are adequate control procedures in place. And of course, only when there are plausible relationships among data, could auditors perform analytical procedures. Examples of common substantive procedures that auditors routinely perform are bank confirmations, account reconciliations, and document matching. The acceptable difference is the amount that requires no further investigation.

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