Substantive Procedures

Angela Besino

11 Oct 202115:52

Summary

TLDRThe video lecture discusses the importance of documentation in audits, focusing on evaluating internal control systems. Auditors must document their understanding of controls, assess control risks, and substantiate their findings if risks are low. It also explains substantive procedures, which are used to detect material misstatements in financial statements. These include analytical procedures and tests of details for transactions, balances, and disclosures. The lecture emphasizes the need for auditors to adjust their procedures based on control risk assessments and the effectiveness of internal controls, ensuring accuracy and compliance throughout the audit process.

Takeaways

📋 The auditor should document their understanding of the entity's internal control using flowcharts or narrative memoranda.
📝 The assessment of control risk, whether high or less than high, must be documented along with the evidence supporting it.
📊 If control risk is assessed as low, the auditor must substantiate their reliance on internal controls, as it poses a higher audit risk.
📂 The level of control risk affects the need for further documentation, especially when the control risk is less than high.
⚖️ Substantive procedures are applied to detect material misstatements at the assertion level and ensure account balances are correct.
🔍 Substantive analytical procedures are used to identify unusual fluctuations for further investigation, especially in large volumes of transactions.
✅ Tests of details can verify transaction accuracy and completeness, involving individual transactions, balances, and disclosures.
💡 Auditors may use substantive analytical procedures or test of details based on the efficiency and effectiveness of procedures in a given context.
🔒 If internal controls are ineffective, auditors rely more on tests of details rather than substantive analytical procedures.
⏳ Performing substantive procedures at interim dates can increase risks if additional procedures are not taken later to ensure accurate detection of misstatements.

Q & A

What is the purpose of documenting the auditor's understanding of internal control?
-The purpose of documenting the auditor's understanding of internal control is to support the auditor's expression of opinion on the audit of financial statements. It serves as evidence for the auditor's assessment of control risk and helps substantiate the auditor's reliance on internal controls.
When is it necessary for the auditor to document the basis of control risk assessment?
-The auditor must document the basis of control risk assessment when the control risk is assessed at a level less than high. This is because the auditor will rely more on internal controls and must substantiate this reliance.
What is the difference between documenting control risk assessed at a high level versus a low level?
-When control risk is assessed at a high level, the auditor does not need to document the basis of the assessment because they do not rely on internal controls. However, if control risk is assessed at a low level, the auditor must document both the assessment and the basis for it to substantiate their reliance on internal controls.
What are substantive procedures, and what is their objective?
-Substantive procedures are audit procedures designed to detect material misstatements at the assertion level. Their objective is to provide evidence that supports the assertion that financial statements are complete, valid, and accurate.
When are substantive procedures always required?
-Substantive procedures are always required, regardless of whether the internal controls are weak or strong. This is different from tests of controls, which may not be required if internal controls are weak.
What are the two types of substantive procedures?
-The two types of substantive procedures are substantive analytical procedures and tests of details. Substantive analytical procedures involve analyzing financial data to identify unusual fluctuations, while tests of details involve examining specific transactions or balances for accuracy and completeness.
When might substantive analytical procedures alone be sufficient for an audit?
-Substantive analytical procedures alone may be sufficient if the audit evidence gathered is considered persuasive, meaning it convinces the auditor that the relevant financial statement assertions are accurate.
What is the difference between a test of transactions and a test of balances?
-A test of transactions focuses on the processing and documentation of individual transactions to ensure they are properly recorded and measured. A test of balances focuses on the amounts in general ledger accounts to verify that they are correct.
What is the primary advantage of analytical procedures compared to tests of details?
-Analytical procedures are generally less expensive and time-consuming than tests of details, making them more efficient for large volumes of predictable transactions. However, they may not be as thorough in detecting misstatements.
How does the timing of substantive procedures affect the audit process?
-The timing of substantive procedures can affect the audit risk. Performing procedures at an interim date may increase the risk of missing misstatements unless additional procedures are performed at the period-end. The auditor may need to modify the nature, timing, and extent of procedures based on the results of interim testing.

Outlines

00:00

📋 Overview of Documentation in Audit Working Papers

The first paragraph discusses the importance of documenting the auditor's understanding of internal controls in the audit working papers. This includes using flowcharts or narrative memorandums to support the auditor’s opinion on financial statements. The auditor should also document the assessment of control risk, particularly if it is assessed as low, and provide evidence to substantiate this assessment. The basis for control risk needs to be documented when assessed as less than high, especially when relying on internal controls to reduce audit risk.

05:02

📊 Substantive Procedures in Auditing

This paragraph introduces substantive procedures, which are designed to detect material misstatements at the assertion level. These procedures aim to verify whether financial statement assertions like completeness, validity, and accuracy are accurate. Substantive procedures are essential for testing material classes of transactions, balances, and disclosures. Unlike tests of controls, substantive procedures are required regardless of the strength of internal controls.

10:03

🔍 Types of Substantive Procedures: Analytical Procedures and Test of Details

This paragraph describes two types of substantive procedures: analytical procedures and tests of details. Analytical procedures help identify unusual fluctuations and are generally used for large volumes of transactions. Test of details focuses on examining specific transactions and balances to ensure they are properly recorded. It also explains how tests of transactions ensure the occurrence and completeness assertions, while tests of balances verify the accuracy of account amounts. The use of these procedures depends on the auditor's professional judgment.

15:05

⏰ Timing and Extent of Substantive Procedures

This paragraph covers the timing of substantive procedures, which may be performed at interim dates if internal controls are effective. The auditor compares interim information with year-end balances to identify deviations. If misstatements are found, the auditor adjusts the timing and extent of substantive procedures. Additionally, this section highlights the need to perform procedures at year-end to reduce the risk of missing material misstatements. The extent of substantive procedures may increase if internal controls are deemed ineffective.

🔢 Extent and Design of Substantive Procedures

This final paragraph focuses on the extent of substantive procedures, particularly how sample size plays a role in testing details. The extent of testing increases when internal controls are unsatisfactory. The auditor must consider other selective testing methods in addition to substantive procedures. The paragraph emphasizes that the appropriateness of testing depends on its relevance to the audit objectives.

Mindmap

Keywords

💡Documentation

Documentation refers to the process where auditors record their understanding of a company’s internal control systems and assessments during the audit process. It is crucial because it supports the auditor’s opinion on the financial statements, particularly when evaluating the reliability of internal controls. In the video, it is emphasized that the documentation could include flowcharts or narrative memoranda to substantiate the auditor's findings.

💡Internal Control

Internal control refers to a system implemented by a company to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud. The auditor assesses whether these controls are effective. The script discusses the importance of evaluating the internal control system to determine the control risk and the need for documenting the auditor's findings, especially if the control risk is low.

💡Control Risk

Control risk is the possibility that a company’s internal controls will fail to detect or prevent errors or fraud in the financial reporting process. Auditors must assess this risk and determine if it is high or low. If the control risk is assessed as low, the auditor must substantiate this with evidence, as mentioned in the script, whereas if it's high, reliance on internal controls is not warranted.

💡Substantive Procedures

Substantive procedures are audit techniques used to detect material misstatements in financial statements. These procedures are designed to test the accuracy, completeness, and validity of the financial records. The video highlights the significance of substantive procedures in ensuring the accuracy of financial assertions, particularly when internal controls are weak.

💡Test of Details

Test of details refers to an audit procedure that involves examining the actual transactions and account balances in detail to confirm their accuracy. This test helps to verify individual items within financial records. In the script, it is mentioned as part of substantive procedures, where auditors inspect documents to ensure transactions are properly recorded.

💡Substantive Analytical Procedures

Substantive analytical procedures involve comparing financial data to expectations based on prior periods or trends to identify any unusual variances that may indicate potential misstatements. The script explains how auditors apply these procedures to large volumes of transactions that tend to follow predictable patterns, making it easier to detect irregularities.

💡Audit Risk

Audit risk refers to the possibility that the auditor may issue an incorrect opinion on the financial statements, either by failing to detect a material misstatement or by relying too much on ineffective internal controls. The video touches on this concept when discussing the importance of documenting assessments, especially when there is a risk that the auditor may inaccurately conclude that financial statements comply with standards.

💡Materiality

Materiality in auditing refers to the significance of financial information in influencing the decisions of users of financial statements. If an item is material, it means its omission or misstatement could affect the decision-making process. The script mentions that auditors place more reliance on substantive procedures for material transactions or account balances.

💡Assertion Level

Assertion level refers to the different claims made by management regarding the financial statements, such as completeness, accuracy, and validity. Substantive procedures aim to verify these assertions. In the video, this is particularly relevant when auditors assess the accuracy of financial statements to detect material misstatements.

💡Timing of Substantive Procedures

Timing of substantive procedures refers to the point in the audit process when substantive audit tests are performed. The video emphasizes that auditors can choose to perform these procedures either during an interim period or at the end of the period, depending on the effectiveness of internal controls and other audit findings. Conducting tests too early without follow-up at the end of the period can increase the risk of overlooking material misstatements.

Highlights

Auditors must document their understanding of internal control using a flowchart or narrative memorandum.

Documenting control risk assessment, whether assessed as high or less than high, is crucial for supporting the auditor's opinion.

If the control risk is assessed as low, the auditor must substantiate this with evidence and document it thoroughly.

Control risk documentation is required only if the risk is assessed as less than high.

Substantive procedures are designed to detect material misstatements in financial statements at the assertion level.

Substantive analytical procedures are more appropriate for large volumes of transactions that tend to be predictable over time.

Test of details involves testing specific transactions or account balances for accuracy and completeness.

Auditors should rely more on substantive procedures for material balances, especially if control risk is high.

Auditors decide between substantive analytical procedures and test of details based on professional judgment regarding the effectiveness and efficiency of these methods.

Performing substantive procedures at an interim date without additional checks at a later period increases the risk of undetected misstatements.

The auditor must perform substantive procedures both during the interim period and at the period end to ensure all misstatements are detected.

If unexpected misstatements are found, auditors must modify the nature, timing, and extent of substantive procedures to cover the full period.

Increasing the extent of substantive procedures is necessary when internal controls are ineffective, but only if the procedure itself is relevant.

Test of details is considered costly and time-consuming compared to other types of procedures, but it is essential for obtaining reliable audit evidence.

Analytical procedures are the least expensive type of substantive procedures and are often used when internal controls are strong.