Substantive Tests for Fixed Assets

A. Presentation and Disclosure

[1]. Read the financial statements in order to verify:

Disclosure of historical cost

Disclosure of depreciation methods under GAAP

Financial statement classification

Disclosure of restrictions

B. Valuation or Allocation

[1]. Examine invoices.

[2]. Inspect lease agreements and ascertain the proper accounting treatment (e.g., capital vs. operating
lease).

[3]. Analyze repairs and maintenance accounts.

[4]. Analyze related accumulated depreciation accounts.

[5]. Vouch entries in fixed asset accounts.

[6]. Test extensions and footings on client-submitted schedules.

C. Completeness

[1]. Perform analytical procedures.

[2]. Inspect fixed assets.

[3]. Examine subsidiary schedules.

[4]. Reconcile subsidiary schedules with general ledger control.

D. Existence or Occurrence

[1]. Inspect fixed assets.

[2]. Examine supporting documentation.

E. Rights and Obligations

[1]. Inspect invoices.

[2]. Inspect lease agreements.

[3]. Inspect insurance policies.

[4]. Inspect title documents.

[5]. Inspect personal property tax returns.

[6]. Read minutes of the board of directors’ meetings.

F. Related Income Statement Effects

[1]. Recalculate depreciation expenses.

[2]. Recalculate gain or loss on disposal of fixed assets.

To form the basis of an opinion on the fairness of the financial statements, the third generally accepted
fieldwork standard requires the gathering of sufficient competent evidential matter. Substantive tests
are the procedures by which auditors gather this evidential matter. Although the nature, extent, and
timing of substantive tests is a matter of professional judgment, effective client internal control is a
positive influence. Accordingly, the auditor may decide to decrease the amount of substantive testing,
omit certain procedures, and/or schedule interim testing.
Conversely, weak internal control will likely result in increased substantive testing, the need for
additional audit procedures, and/or scheduling testing at or after year-end.

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What Is Involved In Substantive Testing?

Well, in general, substantive tests include:

Tests of transactions

Tests of details of account balances

Analytical procedures

In testing transactions, the auditor is concerned with tests of:

Omitted transactions and account understatement (tracing source documents to the books of entry)

Invalid or unsupported transactions and account overstatement (tracing recorded transactions to source
documents).

In analyzing details of account balances, auditors use professional judgment in determining which
accounts to scrutinize. Some of the accounts commonly requiring ‘scrutiny’ are:

Repairs and maintenance

Fixed assets

Officers’ salaries

Contributions

Travel and entertainment

Income tax provisions

Analytical procedures include the study and comparison of the relationships between data. This involves
the comparison of current period financial information with:

Prior period information

Expected results

Predictable pattern information

Intra-industry information

Nonfinancial information

Next are examples of substantive testing procedure for cash, receivables, inventory and fixed assets
balances. Read on…

Substantive Tests of Cash Balances

A. Presentation and Disclosure

[1]. Read or review the financial statements to verify proper classification.

[2]. Read or review the financial statements to verify disclosures such as those relating to compensation
balances.

[3]. Determine the conformity with GAAP.

B. Valuation or Allocation

[1]. Simultaneously count cash on hand and negotiable securities.

[2]. Confirm directly with the bank:

Account balances

Direct liabilities to bank

Contingent liabilities to bank

Letters of credit

Security agreements under the Uniform Commercial Code

Authorized signatures

[3]. Count petty cash fund and reconcile with vouchers.

C. Completeness
[1]. Obtain bank cutoff statement and determine propriety of year-end outstanding checks and
deposits-in-transit.

[2]. Examine or prepare year-end bank reconciliation.

[3]. Prepare a proof of cash.

[4]. Perform analytical procedures.

D. Existence or Occurrence (See Valuation or Allocation)

E. Rights and Obligations

[1]. Read minutes of the board of directors’ meetings.

[2]. Determine existence of compensating balances, levies, etc.

[3]. Verify names on accounts through confirmation requests.

F. Related Income Statement Effects

Substantive Tests of Receivable Balances

A. Presentation and Disclosure

[1]. Determine appropriate classification of account balances.

[2]. Read or review the financial statements in order to verify disclosure of:

Restrictions—pledging, factoring and discounting

Related party transactions

[3]. Trace amounts on trial balance to general ledger control accounts and subsidiary ledger totals.

B. Valuation or Allocation

[1]. Confirm account balances where reasonable and practicable using positive and/or negative
confirmation requests.

[2]. Examine collections in the subsequent period cash receipts journal.

[3]. Examine and verify amortization tables.

[4]. Examine aging schedules.

[5]. Review adequacy of allowance for doubtful accounts.

[6]. Review collectibility by checking credit ratings (e.g., Dun and Bradstreet ratings).

[7]. Verify clerical accuracy and pricing of sales invoices.

[8]. Foot daily sales summaries and trace to journals.

[9]. Perform tests for omitted and invalid (or unsupported) transactions with respect to subsidiary ledger
account balances.

C. Completeness

[1]. Perform sales and sales return cutoff tests.

[2]. Perform analytical procedures.

[3]. Test for omitted transactions.

D. Existence or Occurrence
[1]. Inspect note agreements.

[2]. Confirm accounts receivable and notes receivable balances.

[3]. Review client documentation.

E. Rights and Obligations

[1]. Read minutes of board of directors’ meetings.

[2]. Read leases for pledging agreements.

[3]. Determine pledging and contingent liabilities to bank by using a standard bank confirmation.

F. Related Income Statement Effects

[1]. Review installment sales profit recognition.

[2]. Verify accuracy of sales discounts and term discounts.

[3]. Review bad debt expense computations.

[4]. Recalculate interest income on notes receivable.

Substantive Tests of Inventory

A. Presentation and Disclosure

[1]. Read or review the financial statements to verify footnote disclosure of:

Valuation method and inventory flow, e.g., lower-of-cost-or-market value, first-in-firstout

Pledged inventory

Inventory in or out on consignment

Existence of and terms of major purchase commitments

B. Valuation or Allocation

[1]. Verify the correct application of lower-of-cost-or-market value.

[2]. Recalculate inventory valuation under the full absorption costing method.

[3]. Verify the quality of inventory items.

[4]. Vouch and test inventory pricing.

[5]. Perform analytical procedures.

[6]. Verify the propriety of inventory flow.

[7]. Consider using the services of a specialist to corroborate the valuation of inventory (e.g., a
gemologist to corroborate the valuation of precious stones).

C. Completeness

[1]. Perform cutoff tests for purchases, sales, purchase returns, and sales returns.

[2]. With respect to tagged inventory, perform tests for omitted transactions and tests for invalid
transactions.

[3]. Verify the clerical and mathematical accuracy of inventory listings.

[4]. Reconcile physical inventory amounts with perpetual records.

[5]. Reconcile physical counts with general ledger control totals.

D. Existence or Occurrence
[1]. Observe client inventory counts.

[2]. Confirm inventory held in public warehouses.

[3]. Confirm existence of inventory held by others on consignment.

E. Rights and Obligations

[1]. Determine existence of collateral agreements.

[2]. Read consignment agreements.

[3]. Review major purchase commitment agreements.

[4]. Examine invoices for evidence of ownership.

[5]. Review minutes of the board of directors’ meetings.

F. Related Income Statement Effects

[1]. Verify that ending inventory on the balance sheet is identical to ending inventory in the Cost of
Goods Sold section.

Substantive Tests for Fixed Assets

A. Presentation and Disclosure

[1]. Read the financial statements in order to verify:

Disclosure of historical cost

Disclosure of depreciation methods under GAAP

Financial statement classification

Disclosure of restrictions

B. Valuation or Allocation

[1]. Examine invoices.

[2]. Inspect lease agreements and ascertain the proper accounting treatment (e.g., capital vs. operating
lease).

[3]. Analyze repairs and maintenance accounts.

[4]. Analyze related accumulated depreciation accounts.

[5]. Vouch entries in fixed asset accounts.

[6]. Test extensions and footings on client-submitted schedules.

C. Completeness

[1]. Perform analytical procedures.

[2]. Inspect fixed assets.

[3]. Examine subsidiary schedules.

[4]. Reconcile subsidiary schedules with general ledger control.

D. Existence or Occurrence

[1]. Inspect fixed assets.

[2]. Examine supporting documentation.

E. Rights and Obligations

[1]. Inspect invoices.

[2]. Inspect lease agreements.

[3]. Inspect insurance policies.

[4]. Inspect title documents.

[5]. Inspect personal property tax returns.

[6]. Read minutes of the board of directors’ meetings.

F. Related Income Statement Effects

[1]. Recalculate depreciation expenses.

[2]. Recalculate gain or loss on disposal of fixed assets.