Choosing the appropriate substantive audit procedures

Authro: Iloka Benneth Chiemelie
Published: 16th  Aprl 2017

Introduction

By definition, substantive procedure is a process or test used to create conclusive evidence in relation to the completeness, existence, rights, disclosure or valuation (the first assertions in audit) of assets and/or statement of a company’s financial accounts (AICPA 2006). In order for the process to qualify as a substantive procedures, it is important to collect significant volume of data in order to provide another component auditor with the opportunity of conducting the same procedure on the same documents and being able to make the same conclusion.

Majority of the work undertaken by auditors are aimed at conducting a substantive procedure. If one gas ever worked at an auditing firm, or have experienced companies being audited by an auditing firm, it would be clearer that the request for documentation, reports and other vital information are a continuous part of the auditing experience. Although this might not be a fund experience, it is important to understand that auditors are hired for the purpose of assessing completeness, existence, rights, valuation of disclosure of assets and if the process are not done in the right way or results to wrong information, the whole purpose will not be fulfilled. Although it is understandable that auditors cannot be completely sure of their assessment, it is professionally required that they perform a sufficient evidence based documentation in order to provide reasonable assurance when making conclusions about the auditing process, and this is the basic importance of substantive procedures.

Appropriate substantive audit procedures to be used

Auditors conduct an evaluation of financial records based on the assertions that are embedded in the company’s financial statements. By definition, financial statement assertions represent the management’s explanation about the recognition, measurement, presentation and disclosure of information contained with the company’s financial records. As such, the there are five procedures that should be followed as discussed below.

Existence and occurrence

The first is to ensure that the files contain financial statement that generally include the summary of transactions recorded over the accounting period. The information that are presented on the file need to be supported by necessary accounting records (such as deposit slips and invoices) (AICPA, 2006b). As an example, the company’s machinery are recorded on the balance sheet as an asset and is accompanied with the invoiced used to purchase such machinery. The decision of the management to record the transaction on balance sheet and provide necessary information is an assertion to the fact that the asset does exist and the purchase did, in fact, took place.

Completeness

The accounting records of a transaction in a company’s ledger is in fact a collection of all assets owned by the company, liabilities, shareholders’ equity, expenditure and revenue accounts. The entry’s financial statement contains a summary of every transaction listed in the general ledger (AICPA, 2006b). For instance, the consumers received and paid for equipment that were sold by the company. The management of the company normally deposit funds, retain the deposit slips and record each of the transaction in a general ledger. The ability of the management to offer necessary proof that each of the funds deposited are recorded as revenue on the income statement is a support for the assertion that the presented financial statement are complete and comprises of every transaction within the accounting period such statement were developed.

Accuracy and evaluation

In this assertion, the support offered is the need for all items to be include in the financial statement based on their correct values. As such, all the files will be reviewed on bases of accuracy and the amounts valuated together with other data in order to make sure that the company has recorded the amounts and other events with their appropriate transactions (AICPA, 2006a). In many cases, companies record securities, or stocks as their assets. However, it is evidentially clear that the value of securities change on the daily basis. As such, it is important to ensure that the amount being reported in the financial statement is the appropriate amount at the time of such financial recording.

Rights and obligations

The assertion in this case is the need for management’s statements to have clear definition of company ownership rights to all the assets and the responsibilities of the company for all liabilities that are contained within the financial statement (AICPA, 2006b). It mandated that company must have legal control over the assets and also have legal obligation for associated liabilities in the course of reporting the value of such asset on the company’s financial statement. In cases where reports are made on assets or liabilities that are not owned by the company, the financial account will be misleading and it does reduce overall value of the company.

Presentation and disclosure

In the accounting books, the management are accorded the responsibility of making sure that the company does not make any mistake in the course of processing or planning the financial statement and the disclosures made in the note should be understandable as well as clear. It is important to know that creditors and investors make use of financial rations when comparing between similar organizations in the same industry (AICPA, 2006a). Thus, all presentations must be clear and precise for easy understanding and comparison.

Audit procedures for obtaining audit evidence

The auditor must obtain necessary audit evidence in the course or drawing reasonable conclusions as the bases for the audit opinion. A number of procedures must be followed in the process and they are as discussed below.

a)      The auditor needs to have a clear understanding of the entity and the environment it operates in, including all internal control, in order to conduct detailed assessment of material misstatement within the financial records and different but important assertion levels;

b)      In cases where deemed fit, if the auditor has been able to determine it as so, it is important to test the effectiveness of operating controls in order to prevent or detect material misstatements and the important assertion levels; and

c)      The auditor needs to detect material misstatement at the different levels of assertion (Kendra, n.d; ACCA 2010; ACCA 2012).

In essence, it is mandated that the auditor performs risk assessment procedure to define the right bases for risk assessment for all financial statement and relevant assertion levels. On its own, risk assessment procedures do not offer sufficient evidence for appropriate audit that can be used as the basis for audit opinion, and it is important to support the process with other necessary substantive procedures.

The test of control should be carried out as necessary and they are more important in two circumstances. The first is when the auditor’s risk assessment include an expectation of the operating effectiveness of all control measures adopted, in the case, the auditor needs to test those controls in order to support risk assessment. Secondly, in cases where the substantive procedures on their own do not offer necessary audit evidence, the auditor will need to perform test of control in order to obtain the necessary evidence in relation to their operating effectiveness.

Planning is also necessary, and the auditor needs to plan and perform substantive procedures in response to relevant planned levels for detecting risk, which should include result of test of control, in cases where such are obtainable (ACCA 2010; ACCA 2012). In any case, it should be noted that the risk assessment made by auditors are normally judgmental and might not be sufficiently precise when it comes to detecting all risks associated with material misstatement. Additionally, there are inbuilt limitations within the internal locus of control, which also covers risks associated with management override, the potential for human error, and effects of system changes. As such, irrespective of the risks that have been assessed for material misstatement, it is important for the auditor to design and perform the substantive procedures discussed above s it relates to the assertion made for each material class within the transaction being analyzed, balance of account, and disclosure contained in the statement of account in order to obtain the sufficient audit evidence as appropriate.

The auditor needs to employ one or all the procedures discussed in this case. These audit procedures, when combined, can be used to access risk procedures, test if the controls are effective, determine the substantive nature of the procedures in relation to the circumstances where they are applied by the auditor. Additionally, combining two or more of the audit procedures is important in order to obtain audit evince that are sufficient for performing the tests of controls or substantive procedures within varied levels of assertion. In some cases, the audit evidence gathered form past audits can potentially provide audit evidence where the auditor needs to perform audit procedures in order to determine the relevance for continuation.

The nature and timing of audit procedures to be adopted can be affected by the notion that some of the accounting date and other relevant information might be only obtainable in their electronic form or constraint to only certain points of period in time. Source documents like purchase orders, invoices, bill of lading and check could potentially be replaced with electronic messages (Kendra, n.d; ACCA 2010; ACCA 2012). For instance, entities can make use of electronic commerce or image when processing system. Electronic commerce, the entity and its associated suppliers or customer make use of connected computers within a public network, like the internet, to electronically transact businesses. Shipping, purchasing, cash receipts, billing and other cash disbursements also normally consummated mainly through exchange of electronic message between involved parties. In image processing systems, the documents are normally scanned and converted into an electronic image for the purpose of facilitating storage and reference, and it is possible to retain the source document over the course of the conversion. As such, these information can be retrieved after the specified period if the files are changes and in cases where backup files does not exist. The data retention policy developed by an entity might deem it necessary for the auditor to request retention rights for such information in the case where the auditor needs to review or to perform audit procedures at the period when the information is available.

Conclusion

Essentially, the audit process entails following substantive procedures as described above. The importance of adopting these substantive measures is to ensure that the audit process produces results that are significant correct. Although it is generally understood that producing results that are entirely error proof irrespective of the measures adopted is almost impossible, it is still important to follow these measures established in line with accounting principles. First, the auditor needs to ensure that the case being processed actually exist, the figure and materials needs to be complete in relation to the case being processed, accuracy is also deemed necessary as it relates to the figure or value of the entity’s assets, all the accounting measures need to be evaluated to enhance overall level of accuracy, the entity must maintain legal rights of all assets and liabilities recorded in the financial statement, and the audit must be presented in  clear and easy to understand format. The benefit of such is that it would enhance overall value of the entity through a detail and qualitative description of the entity’s liabilities and assets. As such, it is recommended that the company adopt the substantive procedures described above for the expected benefits associated with such adoption.

Reference

AICPA (2006, a). Audit evidence. Available at: http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00326.pdf [Accessed on: 24^th September 2016].

Kendra, J. (n.d.). What Are Financial Statement Assertions? Available at: http://smallbusiness.chron.com/financial-statement-assertions-3788.html [Accessed on: 24^th September 2016].

ACCA Global (2012). Audit procedures. Available at: http://www.accaglobal.com/content/dam/acca/global/PDF-students/2012s/sa_nov12_f8_fau_audit_procedures.pdf [Accessed on: 24^th September 2016].

AICPA (2006, b). Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained. Available at: http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00318.pdf [Accessed on: 24^th September 2016].

ACCA Global (2010). Analytical procedures. Available at: http://www3.accaglobal.com/content/dam/acca/global/pdf/sa_sept10_audit.pdf [Accessed on: 24^th September 2016].