Audit reasonableness testing is the audit technique or procedure used to assess the reasonableness of accounting transactions, events, or balances that are recorded in the financial statements by auditors by using two or more different sources of data or information to predict accounting transactions or events.
The main principle of this technique is using one event or transaction to predict or assess the reasonableness of others that have a connection with it. For example, the cost of goods sold has a strong connection with sales revenues and inventories.
The auditor might use inventory data or the cost of goods sold to assess the reasonableness of revenues recorded in the financial statements.
Other examples are depreciation expenses and utility expenses. We will explain your detail in this article on how, why, and when you use the reasonableness test.
For example, you are assigned to perform auditing testing in many cycles. One of those cycles is fixed assets. Basically, before you perform the substantive testing on fixed assets that report in the financial statements, you are supposed to understand the key controls of an entity related to fixed assets.
Those controls will be included from the management level of authority on purchasing fixed assets, fixed assets control, and depreciation calculation. Once you complete your understanding, you will decide whether to test the key control or not.
Understanding the key internal control related to the cycle you are testing is a very important part of the success of reasonableness testing. The reason is if you don’t fully understand, you probably miss interpreting the result of your tests.
Let’s say you decided to test the control, and some of those control include purchasing authority and depreciation.
Now, let’s assume that the depreciation charge in the financial statements is correct and that control on the depreciation is concluded to be okay.
Now let’s start the reasonableness test,
As you know, the reasonableness test is part of substantive procedures and now let us use the reasonableness test to confirm if reasonably fixed assets expenses recorded in the financial statements are correct or not.
We assume you understand what depreciation expenses are and how they are charged to the income statement.
Now let’s start testing,
Basically, we know that fixed assets’ depreciation expenses are charged in a systematic way, right?
Once we figure out how those systematic ways are, for example, using the straight-line method, we need to perform the independent calculation of depreciation expenses and then predict the total expenses for the whole year.
But before you compare the expected expenses with actual expenses in financial statements, you should project the threshold on how much difference we will accept and how much we will investigate.
This is how to audit reasonableness test work.
Remember, the reasonableness test is the kind of audit testing that lets auditors understand the reasonableness of balances and amounts of events and transactions recorded in the financial statements.
However, another testing like inspection, vouching, and observation still need to be performed if required.
Why Reasonableness Testing Is Importance in Audit?
There are a number of reasons why the reasonableness test is really important in audits, those include providing the additional audit evidence to the auditor before issuing the audit option, it helps the auditor to reduce the workload on testing the detail of each account that the control is mature, and the risks are not hight.