CHAPTER 10:
SUBSTANTIVE TESTS
OF TRANSACTIONS
AND BALANCES
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
1
RELATIONSHIP BETWEEN TESTS OF
CONTROLS AND SUBSTANTIVE TESTS OF
TRANSACTIONS
• Most controls built around transaction
flows.
• Tests of controls: transactions selected to
test whether related controls are working.
• Substantive test of transactions:
transactions selected to determine whether
monetary errors have occurred.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
2
DUAL PURPOSE TESTS
• These are tests of transactions that address both
control and financial misstatement issues
simultaneously.
• Very common in practice since both tests of
controls and substantive tests of transactions
involve inspection of documents.
• It is efficient to perform tests on transactions
selected simultaneously, e.g. select document and
check evidence of authorisation (test of control)
and recompute amount (substantive test of
transaction).
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
3
SUBSTANTIVE TESTS OF
TRANSACTIONS AND BALANCES
• Objective is to provide reasonable assurance
of validity and propriety of financial report or
identify monetary misstatements and thus
reduce detection risk of auditor.
• Substantive tests of transactions focus on the
individual transactions that make up the
balance.
• Substantive tests of balances substantiate
the ending balance of an account.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
4
DISTINGUISHING BETWEEN SUBSTANTIVE
TESTS OF TRANSACTIONS AND SUBSTANTIVE
TESTS OF BALANCES
Extract from Accounts Receivable Subsidiary Ledger
Customer
Year-end Balance
Able
5000
Baker
500
Chan
1000
•
Transactions for Able
Sales
Receipts
Sales
2000
(1000)
4000
The $5000 balance for Able could be verified by confirming this
balance with customer (test of balances) or verifying to supporting
documentation the three transactions comprising this balance (tests
of transactions).
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
5
FINANCIAL REPORT ASSERTIONS OF INTEREST
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
6
EXISTENCE/ OCCURRENCE AND
COMPLETENESS ASSERTIONS
Note that the direction of testing determines whether
existence/occurrence or completeness assertion is
tested.
existence (of account balance components)/
occurrence (of transactions in accounting records)
Source
Documents
Accounting
Records
Completeness (of accounts balance components or
transactions in accounting records)
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
7
DETERMINANTS OF AUDIT
PROCEDURES USED
Will be determined by:
• The assertion/audit objective to be
tested
• The nature of the item and available
evidence
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
8
CASH, CASH RECEIPTS AND CASH
PAYMENTS — ASSERTIONS OF PRIMARY
INTERESTS
These are primarily:
Cash
• Existence;
• Completeness; and
possibly
• Valuation (if foreign
currency balances).
Cash receipts/payments
• Occurrence
• Completeness; and possibly
• Measurement (if foreign
currency transactions).
- since these are areas where misstatement is most likely to
occur
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
9
APPROACH IN AUDITING CASH
BALANCES
• Determined by assessed level of control risk
in bank and cash handling procedures.
• Much of this information will come from
evaluations and tests of controls in the
sales and cash receipts, purchases and cash
payments systems.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
10
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR CASH BALANCES
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
11
CASH — KEY PROCEDURES
These are:
• Testing of client’s bank
reconciliation
• Obtaining confirmation of bank
balances from client’s bankers
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
12
SALES, CASH RECEIPTS, ACCOUNTS
RECEIVABLE — ASSERTIONS OF
INTEREST
Sales/cash
receipts
•Occurrence
•Measurement
Accounts
receivable
•Existence
•Valuation
- as these are areas in which misstatement is most likely to
occur
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
13
ACCOUNTS RECEIVABLE — KEY
AUDIT PROCEDURES
•
•
•
•
•
•
Confirmation
Subsequent receipts review
Cut-off
Analytical procedures
Tests of sales transactions
Review of aged trial balance
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
14
ASSERTIONS, OBJECTIVES AND
PROCEDURES FOR SALES AND ACCOUNTS
RECEIVABLE
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
15
ACCOUNTS RECEIVABLE —
CONFIRMATION AND OTHER PROCEDURES
Auditor might plan to obtain direct
confirmation from debtors using:
• Positive form — asks client to respond, whether
or not they agree with information as to
amount owed in request
• Negative form — requests client to respond
when they disagree with amount shown
Auditor should also consider other procedures
such as examining evidence of subsequent cash
receipts, and examining sales and shipping
documents.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
16
FORMAT OF POSITIVE ACCOUNTS RECEIVABLE
CONFIRMATION REQUESTS
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
17
CONFIRMATION PROCEDURE VERSUS
SUBSEQUENT CASH RECEIPTS TESTING
Subsequent cash receipts commonly viewed as superior
form of evidence because achieves both key assertions.
Confirmations
• Existence
• Valuation
YES
NO
Subsequent cash
receipts testing
• Existence
YES
• Valuation
YES
Confirmations still require tests of likelihood of payment
(doubtful debts provision).
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
18
PURCHASES AND INVENTORY
• Inventory consists of goods to be sold or
used in the production of saleable goods.
• Transactions involving inventory: increase
to inventory when goods purchased and
decrease to inventory when goods sold.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
19
RISK ASSESSMENT OF
INVENTORY
Inventory generally considered high risk
because:
• Significant to determination of income
• High volume of activity
• Accounting complexities
• Possibility of manipulation in this area
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
20
INVENTORY — ASSERTIONS
OF INTEREST
Two key assertions of inventory are
generally:
• Existence
• Valuation
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
21
INVENTORY — KEY
PROCEDURES
•
•
•
•
Observation of physical inventories
Analytical procedures
Cut-off
Tests of pricing and summarisation
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
22
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR PURCHASES AND INVENTORY I
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
23
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR PURCHASES AND INVENTORY II
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
24
INVENTORY — OBSERVATION OF
PHYSICAL INVENTORY: STOCKTAKE
• Where inventory is considered material,
auditor should attend physical inventory
count (stocktake), unless impractical.
• When attending stocktake, auditor uses a
combination of observation and inquiry and
making test counts.
• If inventory outside auditor’s area of
expertise, should consider utilising services of
expert.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
25
INVENTORY — TESTS OF PRICING AND
SUMMARISATION OF COUNT PROCEDURES
A combination of vouching, tracing and
recomputation. In performing these
procedures auditor’s main concerns are:
• Identifying obsolete, excess and slow-moving
items
• That inventory is counted correctly and results of
inventory count are updated correctly
• That prices for goods are applied appropriately
• That inventory is valued at the lower of cost and
net realisable value
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
26
ACCOUNTS PAYABLE AND
PAYMENTS
• Primary assertion of concern is
completeness, as most likely form of
misstatement is understatement.
• Common audit procedures to address this
assertion are confirmation, a search for
unrecorded liabilities and analytical
procedures performed on related expense
account balances.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
27
ASSERTIONS, OBJECTIVES AND
PROCEDURES OF ACCOUNTS PAYABLE
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
28
NON-CURRENT ASSETS
• The balances of non-current asset accounts
are usually affected by a few relatively large
transactions each year.
• For this reason, it is usually efficient for
auditor to verify account balances by
performing tests on individual transactions.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
29
PROPERTY, PLANT AND
EQUIPMENT
Assertions of interest are generally:
• Existence
• Rights and obligations
• Valuation
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
30
PROPERTY, PLANT AND
EQUIPMENT — KEY PROCEDURES
• Substantiating additions and
identifying retirements
• Considering any revaluations
• Analytically testing or recomputing
related expense accounts such as
depreciation
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
31
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR PROPERTY, PLANT AND EQUIPMENT
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
32
INVESTMENTS AND
INTANGIBLE ASSETS
Assertions generally of interest are:
• Rights and obligations
• Existence
• Valuation
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
33
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR INVESTMENTS
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
34
INTANGIBLES — USE OF EXPERT
• Assertions in relation to valuation
and existence for intangible assets
are particularly subjective given
nature of intangible assets.
• Auditor may consider use of experts
where issues are outside auditor’s
own expertise.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
35
INVESTMENTS AND INTANGIBLES
— KEY PROCEDURES
•
•
•
•
•
Physical examination
Confirmation
Inspection of legal documents
Recomputation, vouching, tracing
Specialised valuation procedures
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
36
NON-CURRENT LIABILITIES AND
OWNERS’ EQUITY
Key assertions completeness:
Key procedures:
• Confirmations
• Reading minutes of meetings
• Examination of contracts and
agreements
• Inspection of share registers
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
37
ASSERTIONS, OBJECTIVES AND PROCEDURES
FOR NON-CURRENT LIABILITIES
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
38
STATEMENT OF FINANCIAL
PERFORMANCE ACCOUNTS:
ASSERTIONS OF INTEREST
•
•
•
•
•
Occurrence
Completeness
Rights and obligations
Measurement
Disclosure
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
39
AUDIT PROCEDURES FOR STATEMENT OF
FINANCIAL PERFORMANCE ACCOUNTS I
• Substantiation indirectly by simultaneous
tests of statement of financial performance
accounts, e.g. sales  accounts receivable;
cost of goods sold  inventory
• Substantiation directly in conjunction with
statement of financial position accounts,
e.g. property, plant & equipment 
depreciation
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
40
AUDIT PROCEDURES FOR STATEMENT OF
FINANCIAL PERFORMANCE ACCOUNTS II
• Substantiation directly by analytical
procedures, e.g. relationships between
amounts that are expected to follow a
predictable pattern such as sales  sales
commission
• Substantiation directly by separate direct
tests of individually significant transactions or
events or account balances of intrusive
interest, e.g. discontinued operations
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
41
AUDITING BY COMPUTER: TESTING
CLIENTS’ FILES
The major way the auditor uses the
computer for substantive tests involves
using audit software to read clients’
master files and/or transactions files.
Major advantages:
• Directs auditor’s attention to items of risk
and/or materiality
• Undertakes routine audit tasks efficiently
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
42
AUDITING BY COMPUTER: FOUR
MAJOR TECHNIQUES
• Generalised audit software — audit interrogation
software used with many clients
• Specialised audit software — audit interrogation
software especially written for client, task or
industry
• Utility programs — routines written by
manufacturer for hardware, e.g. sort, merge
• Systems management programs — enhanced
productivity tools (e.g. data retrieval software)
typically part of sophisticated operating systems
environments
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
43
FUNCTIONS OF AUDIT SOFTWARE
This software can interrogate clients’ files in order
to:
• Select sample items
• Identify records meeting specified criteria
(exception reporting)
• Test and make calculations
• Compare data in separate fields or on separate
files
• Summarise data
• Write reports
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
44
EFFECT OF STRATEGIC BUSINESS
RISK ON SUBSTANTIVE TESTS
• Increased emphasis on tests of controls for
routine transactions implies decreased
emphasis for substantive tests for such
transactions.
• Increased emphasis on non-routine
transactions implies increased emphasis on
substantive tests, as would not expect
sophisticated control systems around nonroutine transactions.
Copyright  2003 McGraw-Hill Australia Pty Ltd
PPTs t/a Auditing and Assurance Services in Australia by Gay & Simnett
Slides prepared by Roger Simnett
45