CHAPTER 8

PERFORMING
SUBSTANTIVE TESTS
LEARNING OBJECTIVES
Define substantive tests.

Classify the different substantive procedures performed in an audit

Describe how analytical procedures are used as substantive tests

Define audit evidence

Identify the attributes of audit evidence

Enumerate factors affecting reliability of audit evidence

Understand the relationship of assertions, audit objectives and audit procedures

List down and explain the different types of audit procedures

Explain how CPAs audit accounting estimate

Define audit documentation and list down the factors which affect the form and
content of audit documentation

Classify working papers and enumerate the elements of working papers

SUBSTANTIVE TESTS
audit procedures designed to:

✓ substantiate the account balances

✓detect material misstatements in the FS

Two types of ST:

1.Analytical procedures

2.Test of details
Using Analytical Procedures as ST
Develop expectations
about the FS

Compare the FS with the

expectations developed

Is the difference
YES Conduct further
investigation
significant?
• inquiries with
management
• corroboration of
NO management’s
responses
Accept the account • other audit procedures
as reasonable
Analytical Procedures as ST
Auditor must apply these procedures on accounts that
are predictable

Generalizations:

Income statement accounts are more predictable

compared to Balance sheet accounts

Accounts that are not subject to management

discretion are generally predictable

Relationships in a stable environment are more

predictable than those in a dynamic or unstable
environment
 TEST OF DETAILS
involves examining the actual details making up
various account balances

Two types:

1.Test of details of balances- direct testing of

ending balance of an account

2.Test of details of transactions- testing the

transactions which give rise to the ending balance
of an account
 Illustration
CASH

Beginning balance 1,000,000

Cash receipts during Cash disbursements
the year 12,000,000 during the year 11,500,000

Ending balance 1,500,000

Test of details of balances

Audit Procedures:
Count the cash on hand
Test the Bank reconciliation
prepared by the client
Illustration
CASH

Beginning balance 1,000,000

Cash receipts during Cash disbursements
the year 12,000,000 during the year 11,500,000

Ending balance 1,500,000

Test of details of transactions

Generalizations:
Materiality
Type of Test Volume of (amount)
Examples
of details transactions per
transaction

• Cash
Test of details
Large volume immaterial • Accounts Receivable
of balances
• Inventory

• PPE
Test of details • Intangibles
of Small volume material • Bonds Payable
transactions • Shareholder’s Equity
Accounts
 EXTENT
-based on auditor;s
NATURE judgment after
-gather evidence with considering the
high quality materiality, assessed
risk and degree of
Effectiveness of assurance
Substantive Tests

TIMING
-Interim procedures are generally
considered as LESS effective
-the higher the risk of Material
misstatement, the more likely it is
that auditor may decide to perform
ST closer to year-end
Relationship between ST and TOC
ST
TOC
- provide evidence about
- provide evidence that
the existence of
indicates a misstatement
misstatement in the
is likely to occur
account balance

Result of TOC is a
major factor in
determining the
nature, timing and
extent of ST
AUDIT EVIDENCE
information obtained by the auditor in arriving at the
conclusions on which the audit opinion is based

Underlying accounting data Corroborating information

refers to accounting records supporting the underlying

underlying the FS accounting data obtained
from client and other sources

Accounting data alone cannot be considered sufficient

evidence to support an opinion on the FS.
AUDIT EVIDENCE
Underlying accounting data
✓records of initial entries
✓general and subsidiary
ledgers
✓related accounting manuals
✓work sheets
✓ spreadsheets supporting
cost allocations,
computations, reconciliations
and disclosures
Corroborating/other
information
✓minutes of meetings
✓confirmation from third
parties
✓checks and records of
Electronic Fund Transfer
(EFT)
✓invoices
✓contracts
✓titles, official receipt
✓result of auditor’s evaluation
of internal control structure
✓calculation of depreciation
expense, tax liabilities
✓representation letter
AUDIT EVIDENCE
QUALITIES OF EVIDENCE:

1. Sufficiency- measure of the QUANTITY of audit

evidence

2.Appropriateness- measure of the QUALITY of audit

evidence and its relevance to a particular assertion and
its reliability
Generalizations on
Sufficiency: The more
The greater material the FS
the risk, the amount being
more audit examined, the
The higher the more evidence
evidence is quality of the is needed!
required! evidence, the
lesser evidence
is required!
Generalizations on Appropriateness:
Relevance relates
Reliability relates
to timeliness of to objectivity of
evidence and its evidence and is
ability to satisfy influenced by its
audit objective source/nature
Illustration on Relevance of Audit evidence

Confirming Accounts Receivable by requesting the client’s

customers who informed the auditor about any differences
between their records of amounts they owe the client and
the client records of open balances is a commonly
performed auditing procedure. When considered in
conjunction with other evidence, a signed confirmation
returned to the auditor indicating agreement with the open
balance can provide support for the management
assertion that the accounts receivable exists and is not
overstated. However, it does not provide evidence about
collectibility, completeness or rights and obligations.
Illustration on Relevance of Audit evidence

A confirmed account may not be collectible because the

debtor does not intend or is unable to pay; receivables
may exist that have not been recorded and therefore
cannot possibly be selected for confirmation or the client
may have sold the receivables to another party and may
merely be acting as a collection agent for that party.

Similarly, physically inspecting and counting inventories

gives the auditor the evidence about its existence but not
about its valuation or about the client’s title to it.
Generalizations on Reliability:
Audit evidence obtained from independent outside
sources is more reliable than that generated internally

Audit evidence
generated Audit evidence
internally is more obtained
reliable when the directly by the
related accounting auditor is more
and internal reliable than
control systems that obtained
are effective from the entity

Audit evidence in the form of documents and

written representations is more reliable than
oral representations
COST-BENEFIT WHEN OBTAINING
EVIDENCE
There should be a rational relationship
between the cost of obtaining evidence
and the usefulness of the information
obtained

Auditor’s judgment is used to determine

the appropriate type of evidence

Auditor relies on audit evidence that is

persuasive rather than conclusive in
nature

Matter of difficulty and expense involved

in testing a particular item is not in itself a
valid basis for omitting an audit
procedure for which there is no
alternative
EVALUATING EVIDENCE
Auditor obtains more assurance
from CONSISTENT audit evidence
obtained from DIFFERENT
sources/ nature than from items of
audit evidence considered
individually.
AUDIT PROCEDURES
According to Purpose

Risk assessment
procedures

Tests of controls

Substantive tests
AUDIT PROCEDURES
According to Nature

Inspection of Records/ Examining records, documents,

Documents whether internal or external, in paper form
or electronic form, or other media

Inspection of Tangible Physical examination of the assets

Assets -provides reliable evidence on existence but not
necessarily about the entity’s rights and obligation
or valuation

Looking at a process being performed by others

Observation
-provides evidence but is limited to a point in time
(on which the observation takes place)
AUDIT PROCEDURES
According to Nature

Recalculation Checking the mathematical accuracy of documents

or records

Seeking information of knowledgeable persons

Inquiry throughout the entity or outside the entity
-Complementary to performing other audit
procedures

Auditor’s independent execution of procedures or

Reperformance controls that were originally performed as part of
the entity’s internal control, either manually or
through the use of CAATs
AUDIT PROCEDURES
According to Nature

Important in establishing the assertion being teste

Direction of the Test by a certain procedure

-Also called as TRACING BACK

Vouching -Examination of SUPPORTING
DOCUMENTS

Tracing

- Tracing of documents to the ACCOUNTING RECO

VOUCHING
EXISTENCE/ OCCURRENCE

OVERSTATEMENTS
TRACING
COMPLETENESS

UNDERSTATEMENTS
AUDIT PROCEDURES
According to Nature
-A specific type of inquiry
- Process of obtaining a representation of informati
Confirmation of or an existing condition directly from a
third party

Situations where external confirmation may be used:

1. Bank Balances

2.Accounts Receivable

3.Stocks held by third parties at bonded warehouses for processing or on consignment

4.Property title held by lawyers or financiers for safe custody or as security

5.Investments purchased from stockbrokers but not delivered at the balance sheet date

6.Loans

7.Accounts Payable
Confirmation
Assertions addressed

Existence

Cut-off

Prepared and signed by the client’s management

Auditor should maintain control over the process of

selecting those to whom a request will be sent,
preparation and sending of requests, and the
responses to those requests
Form of Confirmation Requests
Positive Negative
Confirmations Confirmations

A. POSITIVE B. POSTIVE
CONFIRMATION CONFIRMATION
WITH WITH A REQUEST -Asks the respondent
INFORMATION FOR INFORMATION to reply ONLY in the
INCLUDED -Respondent will be event of
- Risk that the asked to fill in the disagreement with
respondent may amount or furnish the information given
reply without other information - Least reliable audit
verifying that the - Risk of low evidence
information is response rate due to
correct added effort required
Form of Confirmation Requests
Situations where negative
confirmation may be used:

1. The assessed risk of material

misstatement is lower

2.A large number of small balances

is involved

3.A substantial number of errors is

not expected

4.The auditor has no reason to

believe that respondents will
disregard these requests
Follow-Up Procedures for Positive Confirmation
Request
Failure of customers to respond to initial confirmations
often results in 2nd and possibly even 3rd confirmations
being sent.
Alternative Procedures are as follows:
Examination for subsequent cash receipt of the
receivable. This approach is generally considered
to be the best alternative procedure.
Verifying the issuance of the sales invoice and
date of billing.
Examination of shipping documents to determine
if an actual shipment occurred.
Examining correspondence of disputed amounts
between the client and their customer.
Analysis of Differences
Payment has already been made – customer has made a
payment before the confirmation date, but the client has
not received the payment in time for recording before the
confirmation date.
Goods have not been received – client records the sale at
the date of shipment and the customer records the
acquisition when the goods are received.
Goods have been returned – client’s failure to record a
credit memo could result from timing differences or the
improper recording of sales returns and allowances.
Clerical errors and disputed amounts – customer states
that there is an error in the price charged for the goods,
the goods are damaged, the proper quantity of the goods
was not received, etc.
Management Asks Not to
Confirm Information
Perform
VALID? Yes alternative
procedures

No

Qualified
Consider
possible
impact on Disclaimer of
the report opinion
Other Audit Procedures
Audit
Application
Procedures
Agree schedule balances to GL
Analyze account transactions
Compare beginning balance with last year’s audited figures
Count cash, inventory
Examine authoritative documents
Foot totals
Prove totals
Read minutes of directors’ meetings
Reconcile cash balance
Review disclosure, legal documents
Scan for unusual items
 ASSERTIONS AUDIT OBJECTIVES AUDIT PROCEDURES

SALES TRANSACTIONS
TEST OF DETAILS OF BALANCES
EXISTENCE/OCC To determine whether Confirm AR and
URRENCE Sales and AR are for perform alternative
shipments made to procedures for
customers confirmations not
returned
Perform analytical
procedures to test
sales and AR
AUDITING ACCOUNTING
ESTIMATE
Accounting estimate- an approximation of the
amount of an item in the absence of a precise
means of measurement

Management is responsible for making accounting

estimates included in the FS

Estimates are made in conditions of uncertainty,

thus risk of material misstatement is greater
 PROCEDURES IN TESTING
ACCOUNTING ESTIMATE
Auditors should identify all accounting estimate early in the audit

The auditor may evaluate the estimate by the following means:

1. Test the process used by management to develop the estimate

a.Identify controls related

b.Evaluate the sources of data used

c.Determine if assumptions are reasonable and consistent

d.Test the calculations

2.Develop an independent expectation

3.Review subsequent events or transactions

AUDIT
DOCUMENTATION
Also called “Working papers”

record of audit procedures performed, relevant

audit evidence obtained and conclusions reached

include all the information the auditor considers

necessary to conduct the audit adequately and to
provide support for the audit report
Functions of Audit Documentation
Serve as evidence of the auditor’s basis for conclusion

Provide evidence that the audit was performed in accordance with PSAs
and applicable legal and regulatory requirements

Assist the audit team to plan and perform the audit

Assist members of the audit team responsible for supervision to direct and
supervise the audit work and to discharge their review responsibilities

Enable the audit team to be accountable for its work

Retain a record of matters of continuing significance to future audits

Enable an experienced auditor to conduct quality control reviews and

inspections

Enable an experienced auditor to conduct external inspections in

accordance with legal, regulatory requirements
CLASSIFICATION OF AUDIT DOCUMENTATION

A. PERMANENT FILE

-Working papers that are intended to contain historical or continuing

nature pertinent to the current audit

- provides a convenient source of information about the audit that is of

continuing interest from year to year

E.g

1. Extracts or copies of company documents of continuing importance

(Article of Incorporation, by-laws, bond indentures, contracts)

2. Analyses (Long-term debt, shareholders’ equity accounts, fixed

assets)

3. Information related to the understanding of internal control structure

CLASSIFICATION OF AUDIT DOCUMENTATION

B. CURRENT FILE

-Working papers that contain evidence gathered, descriptions of

auditing procedures performed, conclusions reached relevant to
the audit of a particular year

a. Working Trial Balance- list of all FS account balances before

adjustments, as well as the proposed adjusting and reclassifying
entries

b. Proposed Adjusting and reclassifying entries- When the

auditor discovers material misstatements in the accounting
records, the FS must be corrected, but the client must approve
them. Reclassification entries are frequently made in the FS to
present accounting information properly
CLASSIFICATION OF AUDIT DOCUMENTATION

B. CURRENT FILE

c. Lead Schedule- prepared to combine similar accounts

d. Supporting Schedule- largest portion of working paper

includes detailed schedules prepared by auditors in support of
specific amounts on the FS

(e.g bank reconciliation)

Working Paper Elements
1.Heading, showing the name of the client, title of the
working paper, date or period of time to which the
audited information pertains

2.Dates and Initials of staff and reviewers

3. Indexing numbers and appropriate cross-

referencing to other working papers

4.Tick marks and legends

Who owns the Working Papers?

the
AUDITOR
OTHER REQUIREMENTS

PSQC No. 1 requires the firm to establish policies

and procedures for the timely completion of
assembly of audit files

60 days after the date of the auditor’s report

Retention period: No shorter than seven (7) years

from the date of the auditor’s report or, if later, the
date of the group auditor’s report
CONSIDERING THE WORK
OF INTERNAL AUDITOR

INTERNAL AUDITING- an appraisal activity

established within an entity as a service to the
entity

External auditor should obtain a sufficient

understanding of the internal audit activities to
assist in planning the audit and developing an
effective audit approach
 CONSIDERING THE WORK
OF INTERNAL AUDITOR
TWO PHASES:

1. Making a preliminary assessment of internal auditing

- Consider the internal auditor’s:

a. Competence

b.Objectivity

c.Due professional care

d.Scope of function

2.Evaluating and testing the work of internal auditing

- to confirm the adequacy of internal auditor’s work for the external

auditor’s purposes