Chapter 8: Performing Substantive Tests

Substantive tests are audit procedures designed to substantiate account balances or to detect material
misstatements in the financial statements. The auditor’s procedures may either be test of details or
substantive analytical procedures.

Substantive Analytical Procedures

Analytical procedures may be used in the planning, testing and overall review of audit.

Analytical procedures (as per definition in Chapter 5)

It involves analysis of significant ratios and trends, including resulting investigation of

fluctuations and relationships that are inconsistent with other relevant information or deviate
from predicted amounts.

A basic premise underlying the use of analytical procedures is that plausible relationships among
data may reasonably be expected to exist and continue in the absence if known conditions to the
contrary.

PSA requires the use of analytical procedures in the planning stages and overall review stages of
the audit.

Analytical procedures as substantive tests are performed to enable the auditor to obtain corroborative
evidence about a particular assertion.

When analytical procedures identify significant fluctuations, the auditor should conduct further
investigations to determine whether the financial statement are materially misstated.

Suitability of Substantive Analytical Procedures

Substantive analytical procedures are generally more applicable to large volume of transactions that
tend to be predictable over time. A basic premise underlying the use of analytical procedures is that
plausible relationships among data may reasonably be expected to exist and continue in the absence if
known conditions to the contrary.

The following generalizations may be helpful is assessing predictability of the accounts:

 Income statement accounts are likely to be more predictable than SFP accounts
 Accounts that are not subject to management discretion are more predictable than those that are.
 Relationships in a stable environment are more predictable than those in a dynamic or unstable
environment.

Test of Details
It involves examining the actual details making up various accounts.

1. Tests of details of balances

2. Tests of details of transactions

Test of details of balances

- Large volume
- Immaterial transactions

Test of details of transactions

- Smaller volume
- Material transactions

Effectiveness of Substantive Tests. The potential effectiveness of the auditor’s substantive tests is
affected by its nature, timing and extent.

Relationship between Substantive Tests and Test of Controls

Test of control provides evidence that indicates a misstatement is likely to occur.

Substantive tests provide evidence about the existence of a misstatement in an account.

When auditing FS, auditor may design a test of controls to be performed concurrently with test of details
on the same transaction. This is known as dual purpose test.

Audit Evidence

The auditor should obtain sufficient appropriate evidence to be able to draw reasonable conclusion to
which to base audit opinion. Evidence refers to the information obtained by an auditor to which the audit
opinion is based. Audit evidence consists of:

1. Underlying accounting data – accounting records underlying the financial statements

2. Corroborating information – documents and other information supporting the entity’s
accounting data obtained from client and other sources.

Accounting data alone cannot be considered sufficient evidence. Incases where controls cannot be relied
upon, evidence may be obtained entirely from substantive tests. When obtaining audit evidence, the
auditor should consider the sufficiency and appropriateness of audit evidence obtained.

1. Sufficiency – refers to the amount of evidence the auditor should accumulate.

2. Appropriateness – the measure of the quality of audit evidence and its relevance to a particular
assertion and its reliability.

Cost-benefit Consideration.
There should be a rational relationship between the cost of obtaining evidence and the usefulness of
information obtained. Audit evidence does not have to be conclusive to be useful. Ordinarily, the
auditor finds it necessary to rely on audit evidence that is persuasive rather than conclusive in nature.

Audit Documentation/ Working Papers

Working papers are records kept by the auditor that documents the audit procedures applied,
information obtained and conclusion reached. PSA 230 requires the auditor to document matters that are
important to support an opinion on the financial statement, and evidence that the audit was conducted in
accordance with the PSA.

Form, Content and Extent of Audit Documentation

It is neither necessary nor practicable to document every matter the auditor considers during the audit. In
deciding the form, content and extent of the audit documentation, the auditor should consider what would
enable an experienced auditor, having no previous connection with the audit, to understand:
a. The nature, timing and extent of the audit procedures performed
b. The results of the audit procedures and audit evidence obtained
c. Significant matters arising during the audit and the conclusions reached thereon

Classification of working papers

1. Permanent file contains information of continuing significance to the auditor in performing

recurring audits.
2. Current file contains evidence gathered and conclusions reached relevant to the audit of a
particular year.

Working papers are property of the auditor and the client has no right to the working papers prepared
by the auditor.

Although the working papers are the property of the auditor, these papers cannot be shown to third parties
without the client’s permission. However, in some instance the duty of confidentiality is overridden by
the stature of law.

Attendance at Physical Inventory Count

If inventory to the financial statement, the auditor is required under PSA 501 to attend physical inventory
counting, and to test the entity’s final inventory records. Inspecting the inventory when attending physical
inventory counting assists the auditor in ascertaining the existence of inventory, and in identifying
obsolete, damaged or aging inventory.

If attendance is impracticable, the auditor should perform alternative audit procedures to obtain
evidence regarding the existence of inventory.

Failure to obtain sufficient appropriate evidence will cause an auditor to express either a qualified or
disclaimer opinion in the auditors opinion in accordance with PSA 705.
Inventory held by a third party should be obtained by confirmation.

Auditing Accounting Estimates

Accounting estimate means an approximation of the amounts of an item in the absence of a precise
means of measurement. The risk of material misstatement is greater when accounting estimates are
involved.

Responsibility

Management is responsible for making the accounting estimates included in the financial statement. The
auditor’s responsibility is to obtain sufficient appropriate evidence as to whether:
- Accounting estimate is properly accounted for and disclosed
- Accounting estimate is reasonable in the circumstances

Determining accounting estimates are properly accounted for and disclosed requires knowledge of the
client’s business and application of applicable financial reporting framework.

Related Parties

Persons or entities that may have dealings with one another in which one party has the ability to exercise
significant influence or control over the other party in making financial and operating decisions.

Responsibility

Management is responsible for the identification and disclosure of related parties and transactions with
such parties. The auditor needs to obtain an understanding of the entity’s related party relationship and
transactions sufficient to be able to assess the risk of material misstatement and conclude whether
financial statements are fairly presented.

During the audit, the auditor should remain alert when inspecting records or documents that may indicate
the existence of related party relationships or transactions.

When related party transactions are identified, the auditor should obtain sufficient appropriate evidence
that these are properly accounted for and disclosed in the financial statements.

Written representation. The auditor should obtain written representation from the management.
Using the Work of an Expert

An expert is a person or firm possessing special skill, knowledge and experience in a particular field
other than accounting and auditing.

Two kinds of expert:

 1. Auditor’s expert – assist the auditor in obtaining sufficient appropriate evidence.
2. Management’s expert – assist the entity in preparing financial statements.

The auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced
by the auditor’s use of work of an expert. Thus, the auditor should not refer to the work of an expert in
an auditor’s report containing an unmodified opinion.

When an auditor’s report contains a modified opinion, the auditor can make reference to the expert’s
work if the auditor believes that such reference is necessary in order for the readers to understanding the
reason for expressing a modified opinion.

Considering the Work of Internal Auditors

Internal audit is a function of an entity that performs assurance and consulting activities designed to
evaluate and improve the effectiveness of the entity’s governance, risk management and internal control
processes. The external auditor should obtain sufficient understanding of the internal audit function to
assist in planning the audit and developing an effective audit approach.

When planning the audit, the external auditor should make a preliminary assessment of the internal
audit’s function. For this purpose, the auditor should consider the internal auditor’s:
1. Competence
2. Objectivity
3. Due professional care

If based on the foregoing assessment, the external auditor decides to use the work of an internal auditor,
the external auditor will have to evaluate and test the internal auditor’s work to confirm its adequacy
for the external auditor purposes.

Aside from using the work performed by the internal auditors, the externa; auditor may also request the
assistance of the internal auditors in performing routine or mechanical audit procedures.

It is important to remember that all judgements relating to audit of financial statement are those of the
external auditor. The auditor’s responsibility for audit opinion is not reduced by any use made of internal
auditing. Accordingly, the auditor’s report on the financial statement should not include any reference to
the work performed by internal auditors.