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AUDIT TESTS
Audit evidence through Audit Procedures
The auditor needs to generate sufficient appropriate audit
evidence that will allow a conclusion to be
reached based on this. Audit evidence, is obtained from audit
procedures performed during the course of
audit, such as:
• Test of control
(compliance test)
• Test of details
(substantive test)
• Analytical procedures
(substantive test)
Audit Procedures based on the understanding of Internal Control
Auditor’s understanding of the control environment, determines
the audit procedures.
A strong control environment would provide more confidence about
the effectiveness of internal control
and the reliability of audit evidence generated internally
within the entity and thus, for example, allows the
auditor to conduct some audit procedures at an interim date
rather than at period end.
If there are weaknesses in the control environment, the auditor
ordinarily conducts more audit procedures
at period end rather than at an interim date, seeks more
extensive audit evidence from substantive
procedures, modifies the nature of audit procedures to obtain
more persuasive audit evidence, or increases
the number of locations to be included in the audit scope.
Appropriate Audit Approach
The auditor’s understanding of the internal control would enable
him to select an appropriate audit
approach. These audit approaches may be as follows:
1. Apply tests of control only for a particular assertion.
2. Apply substantive procedures only for a particular assertion
may be because auditor failed to
identify any effective controls relevant to assertion.
3. Combined approach i.e. applying both tests of operating
effectiveness of control’s and
substantive procedures for the same assertion.
However, irrespective of the approach selected, the auditor
designs and performs substantive procedures
for each material class of transactions, account balance and
disclosures.
In the case of very small entities, there may not be control
activities and auditor may have to apply only
substantive procedures.
Considering the Nature, Timing and Extent of Audit Procedures
Nature
The nature refers to:
• the purpose i.e. (tests
of controls or substantive procedures) and
• their type, i.e.
inspections, observation, inquiry confirmation, recalculation, re-performances
or analytical procedures.
Timing
Timing refers to when audit procedures are performed or the
period or date to which the audit evidence
applies.
Extent
Extent refers to sample size or number of observations of a
control activity (quantity of audit evidence). It
depends on auditor’s judgment after considering materiality, the
assessed risk and the degree of assurance
the auditor plans to obtain.
Nature
The nature refers to the purpose i.e. (tests of controls or
substantive procedures) and their type, that is,
inspections, observation, inquiry confirmation, recalculation,
re-performances or analytical procedures.
Certain audit procedures may be more appropriate for some
assertions than others.
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75
The types of procedures to be performed and their combination
would be affected by the auditor’s
assessment of the risk. The higher the risk, the more reliable
audit procedure would be required.
In determining the audit procedures to be performed, auditor
considers inherent and control risks
associated with the particular account balance or class of
transactions.
Auditor is required to obtain audit evidence about the accuracy
and completeness of information produced
by the entity’s information system when that information is used
for performing audit procedures.
Timing
Timing refers to when audit procedures are performed or the
period or date to which the audit evidence
applies.
Tests of control and substantive procedures may be performed
either at an interim date or at period end.
The higher the risk of material misstatement, the more likely it
is that the auditor may consider it more
effective to perform substantive procedures near to or at the
period end rather than at an earlier date or to
apply audit procedures unannounced or at unpredictable times. On
the other hand performing audit
procedures before the period end may assist the auditor in
identifying significant matters at early stage of
the audit, which in turn would help in resolving them or
developing an effective audit strategy.
In considering when to perform audit procedures, the auditor
also considers such matters as the following:
• The control environment
• When relevant
information is available (for example, electronic files may subsequently be
overwritten or procedures to be observed may occur only at
certain times).
• The nature of the risk
(for example, if there is a risk of inflated revenues to meet earnings
expectations by subsequent creation of false sales agreements,
the auditor may wish to examine
contracts available on the date of the period end).
• The period or date to
which the audit evidence relates.
Certain audit procedures can be performed only at the period
end.
Examples are:
• Agreeing the financial
statements to the accounting records.
• Examining adjustments
made during the course of preparing the financial statements.
• To cover the risk of
overstatement the auditor ordinarily inspects transaction near the period end.
Extent
Extent refers to sample size or number of observations of a
control activity (quantity of audit evidence). It
depends on auditor’s judgement after considering materiality,
the assessed risk and the degree of assurance
the auditor plans to obtain. Extent of audit procedures is
increased when the risk of material misstatement
increases.
The use of computer-assisted audit techniques (CAATs) may enable
more extensive testing of electronic
transaction and account files. Such techniques can be used to
select sample transaction from key electronic
files, to sort transactions with specific characteristics or to
test an entire population instead of a sample.
Valid conclusions may be drawn using sampling approaches.
However, in certain circumstances
examination of entire population may be more appropriate to
reach a valid conclusion about that
population.
Test of Control
The auditor is required to perform tests of controls
when the internal controls are
operating effectively or when
substantive procedures alone do not provide sufficient
appropriate audit evidence at the assertion level.
Tests of controls comprise of testing
three things:
1. Design – that the internal controls are properly designed to
cover the risk it is meant for.
(examined through ICQs and ICECs)
2. Implementation – that the internal controls have been put
into operation.(examined through a
walk through test with a little sample)
3. Operating effectiveness – that the systems of internal
control were operating effectively at
relevant times during the period. ( examined through compliance
tests based on a judgmental
sample)
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76
Nature of Tests of Controls
These are as follows:
• Inquiry and observation
(e.g. inquiry about and observation of controls over opening of mail to
verify controls over cash receipts).
• Re-performance (e.g.
preparation of bank reconciliation statement);
• Inspection of
documentation relevant to performance of controls;
• Applying CAATs.
• Tests of controls and
tests of details may be applied simultaneously on the same transaction; tests
of control see whether e.g. invoice is approved and tests of
details to detect material misstatement
in that invoice.
Timing of Tests of Controls
These may be performed at
1. a particular time or
2. on the information relating to the entire audit period.
– If performed at a
particular time, it would provide evidence of operating effectiveness of
controls at that particular time. Such evidence may be
sufficient for the auditor e.g.
observation of counting of inventories.
– However, if auditor
wants to obtain evidence about the effective operation of controls
throughout the period under audit, then tests of control’s
should be applied on
transactions of the entire period.
If auditor wants to rely on controls tested in prior periods, he
should make inquiry that there is no change
in such controls. If these controls have changed, these should
be tested for operating effectiveness first
before relying on these.
The auditor may not test all the controls every audit if there
is no change in them. However, such controls
must be tested at least every third audit.
Extent of tests of controls
The auditor designs tests of controls to obtain sufficient
appropriate audit evidence that the controls
operated effectively throughout the period of reliance. Matters
the auditor may consider in determining the
extent of the tests of controls include the following:
1. The frequency of the performance of the control by the entity
during the period.
2. The length of time during the audit period that the auditor
is relying on the operating effectiveness
of the control.
3. The relevance and reliability of the audit evidence to be
obtained in supporting that the control
prevents, or detects and corrects, material misstatements.
4. The extent to which the auditor plans to rely on the
effectiveness of the control (and thereby
reduce substantive procedures based on the reliance on such
control).
5. The expected deviation from the control.
Substantive Procedures
Substantive procedures are performed in order to detect material
misstatements at the assertion level, and
include tests of details of classes of transactions, account
balances and disclosures and substantive analytical
procedures.
The auditor plans and performs substantive procedures to be
responsive to the related assessment of the
risk of material misstatement.
Irrespective of the assessment of risk of material misstatement,
the auditor should design and perform
substantive procedures for each material class of transactions,
account balance, and disclosure.
The auditor’s substantive procedures should include the
following audit procedures related to the financial
statement closing process:
• Agreeing the financial
statements to the underlying accounting records; and
• Examining material
journal entries and other adjustments made during the course of preparing
the financial statements.
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77
When the auditor has determined that an assessed risk of
material misstatement at the assertion level is a
significant risk, the auditor should perform substantive
procedures that are specifically responsive to that
risk.
Nature of Substantive Procedures
Substantive analytical procedures are applied on large volume of
transactions, which are predictable over
time. Tests of details are ordinarily more appropriate to obtain
audit evidence regarding certain assertions
about account balances, including existence and valuation.
In designing substantive analytical procedures, the auditor
considers such matters as the following:
• The suitability of using
substantive analytical procedures given the assertions.
• The reliability of the
data, whether internal or external from which the expectation of recorded
amounts or ratios is developed.
• Whether the expectation
is sufficiently precise to identify a material misstatement at the desired
level of assurance.
• The amount of any
difference in recorded amounts from expected values that is acceptable.
Timing of Substantive Procedures
When substantive procedures are performed at an interim date,
the auditor should perform further
substantive procedures or substantive procedures combined with
tests of controls to cover the remaining
period that provide a reasonable basis for extending the audit
conclusions from the interim date to the
period end.
In considering whether to perform substantive procedures at an
interim date the auditor considers such
factors as the following:
• The control environment
and other relevant controls.
• The availability of
information at a later date that is necessary for the auditor’s procedures.
• The objective of the
substantive procedure.
• The assessed risk of
material misstatement.
• The nature of the class
of transactions or account balance and related assertions.
• The ability of the
auditor to perform appropriate substantive procedures or substantive procedures
combined with tests of controls to cover the remaining period in
order to reduce the risk that
misstatements that exist at period end are not detected.
If substantive procedures are performed at an interim date, the
auditor may sometimes consider applying
tests of controls also on the transactions of remaining period
while extending his substantive procedures
from interim date to the period end.
In situations of actual or expected fraud, auditor may prefer
applying substantive procedures at period end.
If misstatements are detected in classes of transactions or
account balances at an interim date, the auditor
ordinarily modifies the related assessment of risk and the
planned nature, timing or extent of the substantive
procedures covering the remaining period.
Substantive procedures applied in a prior period are not
sufficient to address a risk of material misstatement
in the current year except in certain circumstances.
Extent of performance of substantive procedures
Greater the risk of material misstatement due to weaknesses in
the system of internal control, the greater
would be the risk of material misstatement in the financial
statements.
In designing tests of details, the auditor may use either audit
sampling or may choose to select items to be
tested by some other selective means of testing.
Adequacy of Presentation and Disclosure
The auditor should perform audit procedures to evaluate whether
the overall presentation of the financial
statements, including the related disclosures, are in accordance
with the applicable financial reporting
framework.
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