Session Overview
Test 3 topics
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Tut letter 104: Substantive procedures:
My approach to this session
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General principles, when it comes to substantive
procedures
Developing frameworks for answering substantive
questions
Look at some specifics
See if we can apply the frameworks to answering
questions
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What are “substantive” tests?
Substantive tests…
• Performed in response to
the level of Detection Risk
• Aimed at concluding on the
Rand value of items
• Incorporates
– Substantive tests of detail
– Substantive analytical review
procedures
Tests of control…
• Performed in response to
the level of Control Risk
• Aimed at concluding on
whether or not a control
activity was operating
effectively (“Yes” / “No”
answer)
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The basic principles
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The financial statement assertions
Overstatement vs. Understatement tests
The nature of audit evidence
Designing Substantive procedures
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The financial statement assertions
• These are critical!!!!
• They are what can go wrong in the AFS (what
can cause misstatement)…
• We set out to prove whether they
have gone wrong or not…
• They therefore become the basis for
all substantive procedures – all substantive
procedures set out to gather sufficient,
acceptable evidence to prove that these
assertions are true (have not gone wrong!)…
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The financial statement assertions
• We saw them in session 1
– In ISA 315 para A111 (flag!)
• 3 categories…
– Transactions & events
– Year end balances
– Presentation & disclosure
• Need to recognise that every account
balance contains / records transactions
and / or events
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Transaction & event assertions
• Completeness
• Occurrence
• Accuracy
• Classification
• Cut-off
• Nothing left out – everything that should have
been recorded, was recorded
• Everything that was recorded should have
been recorded (because it happened & it
pertains to the business)
• Everything that was recorded, was recorded
at the correct amount
• Everything that was recorded, was recorded
in the right place / account balance
• Stuff from this year was recorded this year
and stuff from next year was not recorded in
this year.
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Year end assertions
• Completeness • Nothing left out – assets & liabilities that
should have been recorded, have been
recorded
• Existence
• Assets & Liabilities that were recorded should
have been recorded – they are not fictitious
• Valuation
• Assets & liabilities are recorded at their correct
carrying value – what they are worth / their fair
value
• Rights &
• Legal entitlement – assets belong to the client
Obligations
and liabilities are going to be settled by the
client
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Presentation & disclosure
assertions
• Occurrence
• There is nothing in the AFS that
shouldn’t be there
• Completeness • Nothing has been left out of the
AFS
• Accuracy
• Everything in the AFS is in at the
correct amounts
• Classification • Amounts in the AFS are
appropriately disclosed (IFRS /
GAAP / Co’s Act)
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Over vs. Understatement
• Existence / occurrence ensure that the client is not recording
things that they should not be (if wrong, they result in overstatement)
• Completeness ensures that the client is not leaving anything
out (if wrong, it results in under-statement)
• Identifying the direction of the misstatement becomes critical
when designing procedures to try and pick up the misstatement
• Over-statement – must select from what has been recorded to
be able to see if it does in fact belong in the records. (Existence
/ occurrence tests)
• Under-statement – must select from outside the records
(initiating event / what should have been recorded) to see if it
was actually recorded. (Completeness tests)
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Audit evidence (ISA 500)
• Need sufficient, acceptable evidence
• Forms of evidence:
– General sources of evidence…
• Internal
• External / Auditor obtained
– General types of evidence…
• Documentary
• Visual
• Oral
– The strongest – “external and documentary”
– The weakest – “internal and oral”
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Procedures to obtain evidence (para A14)
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Inspection
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Observation
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External Confirmation
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Re-calculation
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Re-performance
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Analytical procedures
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Inquiry
– Of things (documents / assets…)
– Of procedures / activities
– Written responses from external parties
– Checking mathematical accuracy
– Re-doing what the client has done to see if it was done correctly
– Analysis of plausible relationships (refer ISA 520)
– Of people
– Often re-directs us (need to prove what was said to us)
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Overview of subst. audit procedures
• Nature of the test
– What procedure are we going to do?
• Timing of the test
– When are we going to do it?
• Extent of the test
– How much of it are we going to do?
– Influenced by degree of control reliance and degree of risk of
material misstatement
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Designing procedures - Nature
• How are we going to get the evidence?
– Action.. / Verb
– Inspect / inquire / observe /etc…
• What are we going to do / look at?
– What documents are we going to inspect
/ who are we going to inquire of, etc
• Why are we going to do it?
– What are wanting to get / prove from the
procedure?
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The use of Substantive CAATs
• The assertions don’t change…
• The required conclusions don’t change…
• All we are doing is using a computer assisted technique
to help us get the evidence?
• Precede your normal manual procedure with: “using the
CAAT,…”
• Common uses
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Casting & recalculating
Selection of items to test
Review of database for unusual items
Analytical review procedures
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Timing – “interim”
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Usually associated with a tight deadline
Transaction based (never year end procedures)
Tests of control
Substantive tests of transactions
– Tests of detail and / or
– Analytical review procedures
• Will always be a remaining portion of the
transactions to be tested later (usually “after year
end”)
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Timing – “early verification”
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Always associated with a tight deadline
Applies to year end balances only
Always only substantive tests
Will always be “roll forward procedures” required
– Conclusion at verification date
– Plus / minus transactions during the period between
early verification date and year end date
– Equals conclusion at year end…
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Timing – “at year end”
• Certain account balances / assertions can
only be proved at year end
• Inventory!
– Existence
– Completeness
– Valuation aspects
• Establishing cut-off document numbers…
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Timing – “after year end”
• Balance of procedures
– Remaining tests of control
– Remaining substantive tests
• Finalisation procedures
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Subsequent events
Going concern
Management representation
Error evaluation
Audit opinion
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Extent of procedures
• Influencing factors
– Dependence on tests of control?
• If able to place reliance on controls, less substantive evidence
required…
– Risk assessment?
• The higher the risk, the more substantive evidence required…
– Degree of reliance on other evidence (analytical
review procedures? / reliance on other parties?)
• If relying on other evidence, can reduce the extent of “normal”
substantive evidence required…
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Designing procedures to audit
specific Account Balances
• Is it a balance sheet or income statement
account?
• What are the key transactions being posted
into that account during the year?
• Create the framework around the
assertions…
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Specific Examples…
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Refer mind-maps for approach to learning the
framework…
Property, plant & Equipment
Accounts Receivable
Accounts Payable
Inventory
Goodwill
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Other specific ISA’s…
There are open book opportunities for these...
• Enquiry of legal advisors (ISA501)
• Use of external confirmations (ISA505)
• Audit of opening balances (ISA510)
• Analytical procedures (ISA520)
• Audit of accounting estimates (ISA540)
• Auditing related parties (ISA550)
• Management representations (ISA580)
• Use of other parties
– Component auditors – groups (ISA600)
– Internal audit (ISA610)
– Auditor’s experts (ISA620)
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ISA501 – litigation & claims
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Completeness… (para 9)
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Inquiry of management
Review minutes of meetings
Examine legal expense accounts
Consider all info re the business (para A18)
If considered risky, need to communicate with legal council… (para 10)
– Letter prepared by management, sent by auditors
– Usually a list of identified claims, with managements opinion, that we get
them to confirm
– With a request for additional info if list is incomplete / inaccurate
•
Often linked to the accounting considerations regarding provisions for
legal claims (IAS37)?
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ISA510 – Opening balances
• If audited by another auditor – ISA600! (A4 & A5)
• If not, (A6 & A7)…
– some evidence can be obtained through current
transactions (e.g. receipts from debtors prove that they
existed at the beginning)
– Inventory? Current count and roll-back?
– Confirmation (loans, investments, leases, etc.)
• Consider appropriateness of accounting policies
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ISA540 – Accounting estimates (valuation)
• Revised statement combining the “old” ISA 540 and ISA 545
• Detailed statement – worth spending time going through…
• Audit procedures – Para 12 & 13 plus the detailed
explanatory para’s (A13 to A28) - good flags!
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Has management applied the applicable IFRS framework?
Are the methods used appropriate and consistent with the PY?
Review subsequent events for evidence confirming the estimate
Test management process to make the estimate
• Method of measurement used
• Consider assumptions used
– Test operating effectiveness of any controls over the estimate
– Develop independent estimate / range
• Consider use of an auditor’s expert (ISA620)
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ISA 550 Related parties
• Definition – para 10
• Procedures to identify related parties – Para’s 12 to 17
• Procedures to respond to identified related party
transactions – Para’s 21 to 24
• Significant detail in explanatory para’s…
• No need to summarise these – flag and highlight / underline
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Reliance on other parties
• ISA 600 – Group audits…
– Component auditor performing work on components to be
incorporated into group statements OR
– Involving other auditors in the audit of AFS that are not group
statements (para 2)
• ISA 610 – Internal audit…
– Assessing the reliability of the function and evaluating their work…
• ISA 620 – Auditor’s Expert…
– Engaged by the auditor to provide evidence…
• Refer mind map summaries of ISA’s (note the info you
need is all in the ISAs – flag & highlight in the ISA to make
it easier to access)
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Auditing derivative financial
instruments…
• Chapter 17 in Dynamic auditing
• Need to understand these things from an
accounting point of view…
– Definitions?
– Types?
– Accounting treatment?
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Auditing derivative financial
instruments…
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Refer to IAPS 1012 “Auditing derivative financial instruments”
Key financial risks – para 21
Inherent risks – para 27
Control activities – para 39 to 48
Tests of control – para 64 & 65
Substantive procedures (by assertion & detailed!)
– para 77 to 89
• Start with this and consider the degree to which you may need
to supplement this reference material with additional learning
from Ch 17 of Dynamic Auditing…
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Approaching the CTA Q’s
• Let’s review the required and discuss how you
should be “starting” the Q’s contained in the tut
letter…
• Note that there are additional questions from
“Applied Q’s on Auditing” that have also been set –
these should ideally also be attempted (even just as
HLS and as revision before Test 3…)
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Review of assignment q’s
• Q1,
Pg 33…
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Audit procedures on creditors recon…
Audit procedures on long term loan…
Easy question?
Creditors
– Don’t forget the general procedures on a recon
– Deal with each recon item separately (how do you
prove it is legitimate – consider the assertions?)
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Long term loan
– Consider the year end assertions
– Consider the transaction assertions
•
Q2 (Pg 39) – very similar…
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Review of assignment q’s
• Q3,
Pg 47…
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Audit procedures on capitalised development costs…
Development of software…
NB to know IAS 40 in terms of what can be
capitalised or not.
Take each category separately
Consider the assertions (Occ, Acc, Compl, Class,
C/off) as a “checklist”
Don’t forget general procedures…
Classification will require a consideration of whether
the requirements for
capitalisation have been met or not…
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Review of assignment q’s
• Q4,
Pg 49…
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Audit procedures re investment in preference share
Quite difficult – need good knowledge of accounting
for investments & Co’s Act…
But still some easy marks
– General procedures
– Structure your answer i.t.o the assertions
– Consider each assertion separately and get the
obvious points
• Accuracy
• Occurrence (authorisation)
• Classification (accounting treatment
appropriate)
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Review of assignment q’s
• Q5,
Pg 51…
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a) Provision for restoration of land… (15 marks)
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Don’t forget the general procedures
Structure by assertion & consider each one separately (some easy
marks there)
Consider the procedures to be performed on the use of the
environmental consultants (“management’s experts”)!
Consider the appropriateness of the accounting treatment and the audit
evidence required to support this?
b) fair value of inventories… (20 marks)
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Fair value = cost and NRV so separate those…
Cost – split into local AND imported components
NRV – split into identification of items requiring adjustments AND
determining what hey are worth
Refer to ISA540 (estimates) i.t.o the procedures to perform on
management’s estimates?
Refer to the info in the Q always (determine the
procedure first and then relate it to the Q info…)
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Review of assignment q’s
• Q6,
Pg 53…
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Ships! “additional audit work”
a) on costs of the 5th ship; any financial assets or liabilities
related to it’s purchase (9 marks)
b) carrying value of the fleet (12 marks)
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c) any other work relating to the ships (5 marks)
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Refer ISA 540…
Review info in questions carefully to pick up what has not yet been
done…
d) any provision related to the lease of the 4th ship (4
marks)
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Review info in question – around provision for restoration prior to
returning the ship to it’s owners.
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Review of assignment q’s
• Q7,
Pg 57…
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2009 Test 3 question…
a) Audit procedures for JE’s (25 marks)
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For each JE, consider the assertions
Be sure to identify the issues
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Use of other auditors?
Related party transactions?
Relevant accounting requirements (trademarks) to be met?
b) Substantive procedures for warranty provision & leave
provision (20 marks)
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“Easy” question
Take each one independently
Don’t forget the general procedures
Structure around the assertions
ISA540?
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