Chapter 8: Performing Substantive test

Substantive tests are audit procedures design to substantiate the accounting balance or
to detect material misstatement in the financial statement. There are two types of substantive
test, namely analytical procedure and test of details. The decision about which procedure to
use is based on auditor’s judgement about the expected effectiveness and efficiency of such
procedure in satisfying the audit procedure.
Analytical Procedure
it involves analysis of significant ratios and trends, including the resulting investigation
of fluctuation and relationship that are inconsistent with other relative information or deviate
from predicted amounts. A basic premise underlying the use of analytical procedures is that
plausible relationship among data may reasonably be expected to exist and continue in the
absence of known condition to the contrary
PSA 520 requires the auditor to use the analytical procedure in the planning and overall
review stages of audit. In the planning stage of the audit, In application of the analytical
procedures helps the auditor assess the risk of material misstatement in the financial
statement.
Analytical procedure may be used in the planning, testing and overall review stages of the
audit. Analytical procedure applied as substantive test enable the auditor to obtain
corroborative evidence about a particular account. This approach involves comparison of
financial information with the auditor’s expectation to determine the reasonableness of an
account balance reported in the financial statement. When analytical procedures identify
significant fluctuations, the auditor should conduct further investigation to determine whether
the financial statement are materially misstated. This investigation ordinarily begins with the
inquiries of management followed by corroboration of management’s response and other audit
procedure based on the result on the other inquiries.
When intending to perform analytical procedures as substantive test the auditor should focus
on those accounts that are predictable.

Test of details
Test of details involves examining the actual details making up the various account
balances. This approach may take the form of test of details of balances or test of details of
transaction. Test of details of balances involves direct testing of the ending balance of an
account, while test of details of transaction involve testing the transaction which give rise to
the ending balance of an account.
Effectiveness of the Substantive Tests
The potential effectiveness of the auditor’s substantive test is affected by its nature, timing, and
extent.

 Nature of substantive test – it relates to the quality of evidence. The auditor should
determine the appropriate quality of the evidence needed to support the desired level
of detection risk.
 Timing of substantive test – it may be performed at interim date or at year end. Interim
procedures are considered less effective due to the incremental audit risk involve when
auditing interim balances. Performing audit procedure at interim date assist the auditor
in identifying significant matters at an early stage of the audit, and consequently
resolving them with the help of the management or developing an effective audit
approach to address such matters.
 Extent of the substantive test – the extent of the substantive test relates to the amount
of evidence needed to satisfy a particular objective. The extent of the substantive test is
based on the auditor’s judgement after considering the materiality, the assessed risk,
and the degree of the assurance the auditors plan to obtain.
Relationship between Substantive Test and Test of Control
test of control provides the evidence that indicates the misstatement is likely to occur.
Substantive test, on the other hand, provide evidence about the existence of misstatement in
an account balance.
In expressing an opinion in the financial statement, the auditor relies on the effectiveness on
the internal control to prevent material errors in the accounting process, and on substantive
test to verify the amount on the financial statement.
When auditing financial statement, auditors would ordinarily perform test of control
simultaneously with the test of details of transaction in order to increase efficiency in the
application of audit tests. This is called dual-purpose testing.

Audit Evidence
The auditor should obtain sufficient appropriate evidence to be able draw reasonable
conclusion on which to base the audit opinion.
Evidence refers to the information obtained by the auditor in arriving the conclusion on which
the audit opinion is based. Audit evidence consist of underlying accounting data and
corroborating information.
  Underlying accounting data – refers to the accounting record underlying the financial
statement. These include books of accounts, related accounting manuals, worksheet
supporting cost allocation and reconciliation prepared by the client personnel.
 Corroborating information – supporting the underlying accounting data obtained from
client and other sources. This includes documents such as invoices, bank statement,
purchase orders, contracts, check and other information obtained or developed by the
auditor through confirmation, recalculation, observation and reconciliation.
Qualities of evidence
The auditor should consider the sufficiency and appropriateness of audit evidence obtained.
When performing test of control, audit evidence must support the assessed level of control risk,
when performing substantive test audit evidence must support the acceptable level of audit
risk. At the conclusion of the audit, the auditor should evaluate whether the sufficiency and
appropriateness of the of evidence from substantive test and test of control support the
financial statement assertions.

 Sufficiency – refers to the amount of evidence that the auditor should accumulate.
Because of the cost/benefit consideration the auditor does not examine all evidence
available. The auditor uses his judgement to determine the amount of evidence needed
to support an opinion on the financial statements. The following factors may be
considered in evaluating the sufficiency of evidence.
o The competence of evidence – the more competent the evidence, the less
amount of evidence is needed to support the auditor’s opinion.
o The materiality of the item being examined – the more material the financial
statement amount being examined, the more evidence will be needed to
support its validity. Conversely, if the account is not material to the financial
statements, the auditor does not have to perform procedure related to that
account.
o The risk involved in a particular account – the risk of misstatement in a
particular account increase, the more evidence will be needed.
o experience gained during previous audit may indicate the amount of evidence
taken before and whether such evidence was enough.
 Appropriateness – it is the measures of the quality of audit evidence and its relevance
to a particular assertion and its reliability.
o Relevance – it relates to the timeliness of evidence and its ability to satisfy the
audit objectives.
o Reliability – relates to the objectivity of evidence and is influenced by its source
and its nature.
The following generalization could help the auditor in assessing the reliability of audit
evidence:
1. Audit evidence Obtained from independent outside sources.
 2. Audit evidence generated internally is more reliable when the related
accounting and internal control system are effective.
3. Audit evidence obtained directly by the auditor is more reliable than obtained
from the entity.
4. Audit evidence in the form of documents and written representation is more
reliable than oral presentation.
Cost/Benefit consideration when obtaining evidence
An auditor work on economic limits. The auditor’s opinion to be economically useful must be
formed within a reasonable period of time and based on evidence obtained at a reasonable
cost. As a guiding rule, there should be a rational relationship between the cost of obtaining
evidence and the usefulness of the information obtained. Audit evidence does not have to be
conclusive to be useful. The auditor finds it necessary to rely on audit evidence that is
persuasive rather than conclusive in nature and will often seek audit evidence from different
sources or of a different nature to support the same assertion.

Audit documentation / working papers

The sufficient appropriate evidence required by the professional standards must be clearly
documented in the auditor’s working papers. Working papers are record kept by the auditor
that documents the audit procedures applied, information obtained and conclusions reached.
PAS 230 requires the auditors to document matters that are important to support an opinion
on financial statements, and evidence that the audit was conducted in accordance with PAS.
Functions of the working paper
Working papers are primarily to
 Support the auditor’s opinion on financial statements.
 Support the auditor’s representation as to compliance with PAS.
 Assist the auditor in planning, performance, review and supervision of the engagement.

Secondarily, working also assist the auditor in

 Planning future audits.
 Providing information useful in rendering other services ( MAS or tax consultancy).
 Providing adequate defense in case of litigation.

Form, Content and Extent of Audit Documentation

In deciding on the form, content and extent of audit documentation, the auditor should
consider what would enable an experienced auditor, having no previous connection with the
audit, to understand: