Substantive Testing

Summary

This video covers the concept of substantive testing in auditing, emphasizing its importance in providing reasonable assurance that financial reports are free from material misstatements. It begins with a review of audit risk and its components—control risk, inherent risk, and detection risk. The script explains the two main types of audit procedures: tests of controls and substantive tests. Substantive testing focuses on verifying the accuracy of transactions and account balances, and includes three types: substantive tests of transactions, substantive tests of balances, and analytical procedures. The most common type of substantive test is analytical procedures, which assess the reasonableness of account balances using comparisons and relationships.

Takeaways

• 😀 Audit risk refers to the possibility of an auditor issuing an incorrect audit opinion.
• 😀 The audit risk formula is: Audit risk = Inherent risk × Control risk × Detection risk.
• 😀 The auditor must perform procedures to gather sufficient and appropriate evidence for each account and assertion.
• 😀 There are two main types of audit procedures: tests of controls and substantive tests.
• 😀 The choice between these procedures depends on the audit risk model, with more substantive tests performed if control risk is high.
• 😀 Substantive tests check for dollar misstatements in account balances or transactions.
• 😀 The three types of substantive tests are: substantive test of transactions, substantive test of balances, and analytical procedures.
• 😀 Substantive tests of transactions focus on individual transactions, verifying their correctness with supporting documentation.
• 😀 Substantive tests of balances examine account balances for accuracy and completeness.
• 😀 Analytical procedures use comparisons and relationships to determine if account balances seem reasonable.
• 😀 Analytical procedures are the most commonly used form of substantive testing.

Q & A

What is audit risk and why is it important in auditing?

Audit risk is the risk that an auditor may express an inappropriate audit opinion. It is crucial because it helps auditors assess the likelihood of issuing an incorrect opinion, guiding their procedures and evidence gathering.

What formula is used to calculate audit risk?

Audit risk is calculated using the formula: Audit risk = Inherent risk × Control risk × Detection risk.

What does the auditor need to do according to ISA 500?

According to ISA 500, the auditor is required to perform procedures and gather sufficient appropriate evidence for each account and assertion to provide reasonable assurance that the financial reports are free of material misstatement.

What are the two main types of auditor procedures?

The two main types of auditor procedures are tests of controls and substantive tests.

How are substantive procedures chosen in an audit?

Substantive procedures are chosen based on the audit risk model. The higher the control risk assessment, the more substantive procedures are performed.

What is the purpose of substantive testing in auditing?

The purpose of substantive testing is to test for dollar misstatements in account balances or transactions, ensuring that amounts are correctly reported.

What are the three types of substantive tests?

The three types of substantive tests are: 1) Substantive test of transactions, 2) Substantive test of balances, and 3) Analytical procedures.

How does the substantive test of transactions work?

The substantive test of transactions focuses on testing individual transactions and gathering documentation to support their validity.

What is the focus of a substantive test of balances?

The substantive test of balances focuses on testing account balances and their accuracy or completeness.

What is the role of analytical procedures in substantive testing?

Analytical procedures use comparisons and relationships to assess whether account balances appear reasonable. They are the most common type of substantive test.

How do substantive tests relate to the assertions being tested?

Substantive tests are directly related to the assertions being tested. For example, individual transactions can be traced through the accounts to check completeness, or they can be vouched back to original documents to verify existence or occurrence.