Test of controls and Substantive procedures in audit of financial statements.

 

Auditors use test of controls and substantive procedures to respond to the assessed risks of material misstatement at the assertion level.

Test of controls are  audit procedures designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level.

Tests of controls are performed only on those controls that the auditor has determined are suitably designed to prevent, or detect and correct, a material misstatement in an assertion.

Testing the operating effectiveness of controls is different from obtaining an understanding of and evaluating the design and implementation of controls. However, the same types of audit procedures are used.

Audit procedures used to test the operating effectiveness of controls

·        Inquiry.

·        Inspection, review.

·        Observation.

·        Reperformance.

The auditor shall test controls for the particular time, or throughout the period, for which the auditor intends to rely on those controls in order to provide an appropriate basis for the auditor’s intended reliance.

 The audit evidence about operating effectiveness of control obtained during an interim period may be used if the auditor obtains audit evidence about significant changes to those controls subsequent to the interim period.

In determining whether it is appropriate to use audit evidence about the operating effectiveness of controls obtained in previous audits, the auditor must consider the following:

·        The effectiveness of other elements of internal control.

·        The risks arising from the characteristics of the control, including whether it is manual or automated.

·        The effectiveness of general IT controls.

·        The nature and extent of deviations in the application of the control noted in previous audits,

·        The risks of material misstatement and the extent of reliance on the control.

A substantive procedure is an audit procedure designed to detect material misstatements at the assertion level. Substantive procedures comprise:

(i)               Tests of details (of classes of transactions, account balances, and disclosures); and

(ii)              Substantive analytical procedures.

Irrespective of the assessed risks of material misstatement, the auditor must design and perform substantive procedures for each material class of transactions, account balance, and disclosure.

Substantive Procedures Related to the Financial Statement Closing Process such as

·        Agreeing or reconciling information in the financial statements with the underlying accounting records, including agreeing or reconciling information in disclosures.

·        Examining material journal entries and other adjustments made during the course of preparing the financial statements.

Substantive Procedures Responsive to Significant Risks

If the auditor has determined that an assessed risk of material misstatement at the assertion level is a significant risk, the auditor shall perform substantive procedures that are specifically responsive to that risk.

Adequacy of Presentation of the Financial Statements

The auditor should perform audit procedures to evaluate whether the overall presentation of the financial statements is in accordance with the applicable financial reporting framework:

● Classification and description of financial information and the underlying transactions, events and conditions; and

 ● Presentation, structure and content of the financial statements.

Substantive Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

An example of substantive analytical procedure could be the comparison of the current year receivables collection period to that of the prior year.

Tests of details are used to test assertions about classes of transactions and events, and related disclosures and assertions about account balances, and related disclosures. Tests of details include:

·  Inspection involves examining records or documents, whether internal or external, in paper form, electronic form, or other media, or a physical examination of an asset.

·   Observation consists of looking at a process or procedure being performed by others, for example, the auditor’s observation of inventory counting by the company’s personnel, or of the performance of control activities.

·   External Confirmation represents audit evidence obtained by the auditor as a direct written response to the auditor from a third party.

·   Recalculation consists of checking the mathematical accuracy of documents or records.

·   Inquiry consists of seeking information of knowledgeable persons, both financial and non-financial, within the company or outside the company.

Example of tests of details regarding the existence of company property could be a physical examination of an asset (inspection).

ISA 500