Compliance tests provide the auditor with indirect evidence, the auditor therefore cannot on the strength of compliance test alone reach a conclusion as to whether or not a balance is fairly stated. The auditor therefore carries out substantive testing to obtain more assurance on the reported balances.
Substantive tests are those tests balances and transactions and other procedures such as analytical review, which seek to provide audit evidence as to the completeness and accuracy and validity of information contained in the records and or the financial statements. Substantive tests are those tests carried out by auditors to confirm the assertions of the management i.e. existence, rights and obligations, occurrence, completeness, valuation, measurement and presentations and disclosure.
For tangible assets existence can be confirmed through physical inspection. During the inspection the auditor also considers the condition of those tangible asset as valuable evidence to the reasonableness of valuation.
For liabilities and assets such as debtors, cash at bank; the auditor would be satisfied with third party confirmations. Intangible assets such as goodwill and deferred development expenditure; the prevailing circumstances give guidance as to whether that intangible asset exists.
Right of obligations:
The ownership rights to assets can be confirmed through the inspection of title documents to confirm that such the title documents are in the name of the company. Documents of title include: title deeds and motor vehicle registration. Where there is no document of title proof of purchase and possession will suffice. That is evidence that the client ordered for the goods, paid for them or is acknowledging liability for them, they are in his possession and there’s no evidence to indicate any other party has a claim to those goods then the client has a right to those goods.
Testing for occurrence involves verifying that a transaction actually took place during the year. This is tested through inspection of the documents raised in carrying out the transaction. E.g. the occurrence of a purchase transaction can be verified by inspection of the purchase order raised at the initiation of the transaction and the resulting purchase invoices raised by the supplier.
Completeness tests are designed to confirm that there are no unrecorded assets, liabilities or transactions.
- For documents that are pre-numbered the auditor can test for the numerical sequence investigating any missing numbers.
- Cut-off procedures are performed to confirm that transactions with their related movement of assets have been fully recorded in the same and correct accounting periods.
- Review of reconciliation between control accounts and subsidiary records and between subsidiary records and third party records.
Most balances are valued at cost plus or minus a provision. Both cost and provision will involve an accounting policy considered most appropriate by the client for their circumstances:
The auditor will:
- Determine the clients accounting policy
- They will then test the suitability of that policy
- If suitable test the application of that policy.
It involves determining that recorded events or transactions have been recorded in the correct amounts and if it’s revenue or expense it has been allocated to the correct period.
Measurement is closely related to occurrence and valuation and in addition therefore to the procedures discussed under occurrence and valuation the company’s capitalization policy is critically reviewed for its continued suitability.
Presentation and Disclosure:
The categorization, classification, description and disclosure of transactions and balances in the books of accounts or financial statements may be governed by the company’s act disclosure requirements, accounting standards or other regulations. Usually by use of a checklist the auditor compares the clients presentation and disclosure with the presentation and disclosure requirements.
Analytical review tests, which are included in the description of substantive tests, provide evidence as to the completeness and occurrence and measurement of events and balances.
Exceptions of substantive tests:
In substantive tests transactions speak for themselves therefore any error or deviation is measured for its materiality or effect on the financial statement or the recorded balance.
Compliance tests give indirect evidence to the auditor and if the conclusion from them is positive then it assures the auditor that there were measures in place to minimize misstatements. This then reduces the extent of detailed substantive testing. It is possible to carry out a purely substantive audit and make a valid conclusion without any reliance on any internal controls.
After the substantive test the auditor can conclude that proper records have been kept and that the accounting system is adequate and is a reliable basis for the preparation of financial statements.