Substantive Audit Procedures

Introduction:

Auditing is considered as a very integral function of the business because it validates the extent to which operations and financial standing within the company have been taken care of.

In this regard, it is increasingly important to recognize the fact that the process itself is supposed to be designed and executed in the manner in which the best possible results can be achieved.

In this regard, there are numerous different steps and processes that should be carried out in order to ensure that the audit process is designed to cover all audit assertions, so that there is no ambiguity regarding the way forward with the audit process.

Substantive audit procedures tend to be one of the most important aspects of the audit process, because of the important role it plays in the gathering the required evidence for the audit.

Definition:

Substantive audit procedures can be regarded as processes or steps that are taken by the auditors to create conclusive evidence pertaining to completeness, existence, disclosure, rights, or valuation of assets.

Therefore, this is mainly about gathering conclusive audit procedures, so that a conclusion can be reached upon, pertaining to the underlying audit procedure.

These processes, are therefore, carried out by the auditors in order to ensure that there are no material misstatements in the financial statements.

Usually, a procedure is considered as a substantive audit procedure only I the two auditors who carry out this particular task are able to reach the same conclusion pertaining to the audit assertion as the other auditor.

Types of Substantive Audit Procedures:

There are two main tests of substantive audit procedures. Firstly, there is a Test of Detail, and secondly, there are Analytical Procedures.

As far as the Test of Detail is concerned, it can be seen that it mainly includes verification of transactions, account balances, as well as to disclosures.

This is an important component because of the reason that it helps the auditors to ensure that there are no malpractices evident in the reported transactions within the companies.

In the same manner, it is also imperative to ensure that these details have been corroborated in order to gather the much needed reasonable accuracy relating to that specific component.

On the other hand, as far as Analytical Procedures are concerned, it is deduced that it consists of evaluations of financial information through analysis of plausible relationships among financial, as well as non-financial data.

They mainly comprise of investigation of different identified fluctuations that are relatively inconsistent with other information within the same threshold.

As a matter of fact, both these types of substantive audit procedures contribute in a different manner towards the audit process, because they tend to focus on the minute details of the audit transactions that have been reported so that a better conclusive judgment can be drawn.

Examples of Substantive Audit Procedures

As mentioned earlier, substantive audit procedures can be defined as numerous verifications and checks that are carried out on numerous different levels in order to ensure that all necessary ground has been covered.

In general, substantive audit procedures can include the following:

  • Examination of documents that indicate that the procedure was performed
  • Performing procedures twice (or more, if required), to ensure that procedure functions as expected
  • Inquiring or observing regarding transactions that take place

In order to conduct procedures like the ones mentioned above, substantive audit procedures will have to be conducted including bank confirmation, accounts receivable confirmations, observation of physical inventory counts, observation of fixed assets, confirmation of account payables, the examination of accounts receivable as well as confirmation of the debt.

Importance of Substantive Audit Procedures

As a matter of fact, substantive audit procedures are deemed important because they tend to provide backing and claim regarding the judgement that has been made by the auditor.

It is considered as an increasingly important part of the audit process, because of the reason that it tends to eliminate any unwarranted claims that could otherwise have been put forth by the auditor.

Therefore, it adds a layer of validation within the audit process because they know that these audit procedures have been carried out in sufficient detail.

Conclusion

Therefore, it can be seen that Substantive Audit Procedures can be considered as a really crucial aspect of the overall audit process because of the fact that they tend to provide the groundwork for the claims made by the auditor.

They ensure that there are no discrepancies or misstatements in the financial statements, and therefore, this greatly helps them to determine that no overgeneralizations have been made in this regard.

Audit Procedures for Cash and Cash Equivalents

Introduction

Audit procedures are considered integral in facilitating a smoothly conducted audit process that can deliver the required results.

Given the high degree of importance that is tied with the audit process, it is imperative that planning within the audit function is taken care of in a serious manner so that planning and execution within the audit process are carried out in a better manner.

During the audit process, it can be seen that audit procedure are designed so that sufficient groundwork is obtained so that reasonable assurance can be gathered before making a statement.

As far as cash is concerned, it can be seen that it is regarded as a relatively risky asset stream because of the reason that it might be used without proper authorization.

Given the liquid nature of the cash assets, it can be seen that there is a need to ensure that this is properly audited, because of its vulnerability to be under fraud, or malpractice.

Audit Procedures for Cash and Cash Equivalents

Firstly, when deciding upon the audit procedures that are used for cash, there is a need to ensure that there is proper clarity regarding the existing business model of the client, as well as internal control policies that are in place in order to ascertain the groundwork that needs to be covered in this regard.

When auditors test for cash and cash equivalents, there is a need to ensure that they are able to cover the respective assertions for cash, on the following grounds:

  • Existence: This is to check if the cash balances on the balance sheet exist at the date of financial statements or not. This is checked by ensuring that the bank statements that are issued by the bank have the respective balance that is declared on the balance sheet by the company or not.
  • Completeness: This measure checks if the cash balances actually include all the cash transactions that have taken place during the accounting period. In the case of transactions taking place within the company, all records are duly maintained. For example, a sales invoice would be proof that the debit transaction in the company’s books is actually because of sales income.
  • Rights and Obligations: This is to verify that the company has the legal right to declare the amount of cash it has declared, on the reporting date. This calls for companies to have sufficient proof that they own that particular cash, or cash equivalent. For example, they cannot declare money not yet received from a customer as a cash or cash equivalent.
  • Values/ Allocation: This assertion verifies that the recorded balances actually reflect the true underlying economic value of cash. This amount should not be overstated, and should be included as per the existing value in the bank accounts, or the equivalents that the company has.
  • Presentation and/or Disclosure: Cash should be properly disclosed in the balance sheet with adequate and required disclosure made in the notes to the statements. All the sources of cash should be properly disclosed, with any other information that is relevant to the shareholders. The cash and cash equivalents should be broken down into cash in the bank, and other cash that the company might have on the reporting date.

Keeping these assertions in mind, the auditor is then supposed to check for various different procedures for cash, which include the following.

Bank Confirmation: This process is mainly undertaken in order to ask for verification or confirmation to the external party, which is primarily cash, as well as the underlying balances the company actually holds at the bank.

In order to verify the balance at the bank, it is rudimentary for the company to ensure that they are able to obtain a formal, writer authority by the relevant bank, so that the bank can disclose the respective information to the client with proper information.

Furthermore, once the authorization process has been covered, it is important to follow up on all the points of the bank confirmation.

Bank Reconciliation: This tends to be another integral component of the audit procedure for cash and cash equivalents.

This is because after the bank confirmation and statements have been issued, the auditor is supposed to compare the bank statements sent by the bank and the cash statement prepared by the bank in order to check for any discrepancies.

In this regard, they are supposed to check and agree with the balances per bank statement that is shown on the reconciliation to the bank statement as well as balances that are shown otherwise.

This also tests these balances arithmetically, to ensure that there are no discrepancies in the calculation, whatsoever.

These audit procedures to check for cash and cash equivalents is created in order to ensure that there are no differences in the actual amount the company owns, and the amount it has disclosed on the balance sheet.

In the same manner, this backward trail also helps to identify any leakages or potential areas of fraud within the cash system of the company.

Conclusion

As a matter of fact, it can be seen that audit procedures for cash and cash equivalents can be considered as an integral part of the audit.

This is because of the reason that the audit procedures are conducted in order to ensure that there are no existing discrepancies, and the work is carried out as per the required standards.

In this regard, it is imperative that auditors take their time in evaluating these procedures so that there is no ambiguity, and any chances of errors or fraud can be discovered well in time.

Audit procedure for related party transactions

Introduction

Related Parties Transactions are transactions that take place within an organization that takes place with other organizations that are directly, or indirectly related to the organization in question.

As a matter of fact, related party transactions might include transactions between a parent entity and its subsidiaries, subsidiaries of a common parent, an entity, and related entities for the benefits of stakeholders (mainly employees), an entity and the principal owners and managers, and other affiliated entities.

Importance of Audit Procedures for Related Party Transactions

There is a need to ensure that related party transactions are properly adhered to because it is important for the stakeholders to be aware of the existing negotiations that might take place between an entity and its relevant parties.

Also, the overall scope of a potential collaborative behavior in this regard is also highly likely, as a result of which it becomes important to notify the stakeholders of the affiliation, so that any red flags can subsequently be identified.

Additionally, it can be seen that related party transactions mainly involve contracts for goods and services that are mainly priced at lesser amount, as compared to the transactions that take place between unrelated third parties.

The reason that these transactions need to be closely monitored lies on the realms of ensuring that there are no kickbacks, or uncalled for advantages taken in this regard. Therefore, it becomes the responsibility of the auditors to take these issues into account so that there are no red flags for that matter.

Audit Procedure for Related Party Transactions

The audit procedures for related party transactions are highly important to be considered because of the fact that there is an underlying potential for undisclosed related party transactions that need to be accounted for by auditors to look for probable incidents of fraud. Certain examples pertaining to related party transactions can be as follows:

  • Firstly, auditors are required to obtain a list of the company’s current related parties and associated transactions.
  • Subsequently, they also obtain minutes from the board of directors’ meetings, especially in the cases when the board discusses significant business transactions.
  • It is also useful to consider disclosures from board members, as well as senior executives pertaining to the existing ownership of other entities.
  • Bank statements and transaction records, which comprise of intercompany wires are also helpful because they provide certain automated clearing house (ACH) transfers, as well as check payments.

Therefore, specific audit procedures that target related-party transactions in this regard include the following specific steps:

  • The need to test the overall viability of related party transactions, and subsequently identifying them to be coded in the ERP system.
  • Conducting interviews with accounting personnel that is responsible for reported related-party transactions in the company’s financial statements
  • Critically analyzing presentation of related-party transactions in the financial statements

Objectives to be considered when designing Audit Procedure for Related Party Transactions

When auditing related parties, the fundamental aspects that should be considered by auditors are two-fold. Firstly, they are supposed to recognize fraud risk factors that may lead to material misstatement of the accounts, owing to the act of fraud itself.

Secondly, they are also supposed to conclude if there is fair representation of the related party transactions in the financial statements, and if the disclosures meet applicable financial reporting framework.

Audit Skepticism in Related Party Transactions

Professional skepticism in related party transactions is a very important phenomenon that needs to be withheld when it comes to designing procedures and protocol for related party transactions.

As a matter of fact, it can be seen that it calls for auditors to remain vigilant and alert about any undisclosed related party transactions, as well as maintaining skepticism when it comes to identifying material misstatements in the transactions.

Conclusion

Therefore, it can be concluded that it is very important for audit procedures to be designed carefully when it comes to related party transactions.

As a matter of fact, it is highly important to recognize the fact that related party transactions pose a higher risk because there are possibilities of inappropriate accounting, non-identification or non-disclosure, fraud, and the underlying ability of the business to be safely regarded as a growing concern.

The possibility of a coordinated effort towards collusive behavior within affiliated parties of the company has continued to be a pressing cause of concern which also poses increased risks.

Therefore, auditors are required to create procedures for related party transactions with relative ease, so that they are able to assess and disclose any material misstatement or activity from the financial statements.

Audit procedures for goodwill

What is goodwill?

Goodwill is normally considered as intangible non-current assets in the consolidated statement of financial position when a company purchases another company where the value of net assets of the company being purchased is less than purchase consideration.

For example, ABC Co purchased 100% of DEF Co shares of USD500,000 in cash and the net assets of DEF Co are USD450,000. In this case, ABC Co will have to recognize a goodwill amount of USD50,000 in its consolidated financial statements.

This goodwill will have to  review for impairment annually and if there is any impairment then the value of goodwill will then be reduced by the impairment

To audit goodwill that reports in the company financial statements, auditors need to obtain an understanding of how the goodwill occurs, recognize, measures as well as review. 

Audit procedures:

The following are the list of basic procedures that should be performed when auditing goodwill:

  1. Review purchasing agreement: As we just men above, goodwill is recognized when a company purchased another company, and the consideration value is more than the net assets value. To assess if the information is correct, auditors should obtain purchased agreement between both companies. The auditor should also review if the date of the purchasing date is agreed with the recognition date of goodwill in the financial statements. Once the agreement is obtained, the auditor review the purchase agreement to see if the consideration paid consideration payment and other payment requirements are correct.
  2. The auditor should also see is there any contingent consideration. Confirm this information is correctly incorporated in the goodwill calculation. In addition, auditors should obtain the payment vouchers to see if the payment has actually occurred. Cross-checking the payment amount to bank statements might need to be performed.
  3. Ownership is also one of the important factors to determine the value of goodwill recognized in the financial statements. Once the purchase agreement is completed, auditors should confirm the correctness of ownership in the company’s shares registration documents. The legal documents that have the registered share might be different from one jurisdiction to another. And this kind of documents should have been obtained from the regulator once sell and purchase agreement are agreed by both parties.
  4. Review the board meeting minutes. After reviewing the ownership, auditors should also review if the purchasing transactions are authorized by the boards. The review should include the purpose of purchasing, purchasing price, as well as the date of purchasing.
  5. Before purchasing, the company normally ask the accounting firm to do the due diligence to assess the net assets of the targeted company. It is always advised to obtain the due diligence report to assess what is the net assets value, what are the key assets, and how much is their value. The report also has the value of liability as well as the details of those liabilities.
  6. The auditor should also perform their own calculation on goodwill to see if the goodwill that calculates by the client is correct. If the result shows different, then the auditor should inquire about management and ask them for the explanation.
  7. Review impairment testing. Goodwill impairment should be assessed annually by the client; therefore auditor obtained the assessment and review if the assessment is correctly performed.

Audit Procedure for Accrual

Overview:

In accounting basic, most businesses normally use one of two accounting basic for their company to record accounting transaction in the system, cash basis or accrual basis.

It is depended on the nature of the company whether they use a cash basis or an accrual basis.

A cash basis is a method that the book is kept based on actual cash in and out of the Company. With accrual basis, income and expense are recorded when they have occurred whether on credit or by cash.

Understanding Control:

Anyway, accrual is referred to as the accounting concept or principle that is used to recognize expense and income of the Company that has been consumed or earned within the specified reporting period, and It is also to ensure that the Company’s expense and income are recorded and recognized based on actual.

Below are some examples of accrual that normally happened in respective companies;

  • Utility expense is subjected to be accrual in the month that invoice is not received from the supplier by recording as a debit to a utilities expense account for the month which presented in Income Statement and credit to accrual on utility expense account which presented in Balance Sheet.
  • Utility income is subjected to accrual. Normally, the Companies that provide electricity to their customers, bill invoice to them in the following month. Mean that electricity was used in the last month, but the invoice is billed in the current month.
  • Salary expenses normally need to accrual since they are not normally paid in the month that employees are providing their services to the company. However, the salary expenses do not need to be accrued when the payments are made at the end of the month, year, or accounting period.

Assertions:

  • Completeness: To ensure the completeness of the accruals in the balance sheet, the auditor has to reconcile detailed listings of accruals to trial balance (TB). If there is variance, further reconciliation must be performed.
  • Existence: There are the risks that accruals that presented in the detailed listing of accruals might not exist.
  • Right and Obligations: Company liabilities are recognized in the financial statements represent the obligations of the Company. Auditor has to check and verify supporting documents of the accrual whether the accrual belongs to the Company’s obligations or not.
  • Presentation and disclosure: This assertion is concerning the disclosure of significant information that matters to other users of the financial statements. That information includes accounting manual, credit term for expense and revenue recognition for recording accrual.

Common Risks Related to Borrowings audit:

Audit risks related to accrual are varied based on the nature of the business and auditor’s understanding of the business’s control. The following are the risks that normally come up when performing an audit on the accruals;

  • Overstate and understate the accrual amount recorded in the system. Auditor has to assess the reasonableness of the accruals methods.
  • The discrepancy between balance per recording and its supporting documentation. Auditor has to perform testing on accrual transactions by selecting some transactions from GL or from the listing of the accruals. Adjustment should be made if any variance between the accounting records and per its supporting document.
  • Posting accruals in the system without proper supporting documents. Auditor has to perform an understanding of its control over the recording of accruals and walk-through its supporting document.

Audit Procedures:

  • Obtain detailed listings of accruals to reconcile to GL or TB: Auditor should obtain detailed listings of accruals of the Company to reconcile with financial statements for the period of auditing.
  • Assess the reasonableness of management’s assumptions used in the assessment of accruals.
  • Compare estimates made in prior periods with actual results for those periods.
  • Determine whether accounting estimates made by the management of the Company in this area represent a risk of material misstatement (overstate or understate).

Written by Chancrersna

Audit Procedure for Advertising Expenses

Overview:

Advertising expense is one of operating expense that joint with other expenses to operate the business. To perform an effective and sufficient testing on this expense, auditor has to focus on both control testing and control validation.

Firstly, auditor has to perform understanding and study on overall picture of advertising expense before going detail to its audit procedures.

Understanding Control:

Getting more understanding on the nature of the advertising expense is an advantage for auditor to design audit procedure.

Advertising expense is an expense account which presented in Income Statement of the company. The position of this account is varied based on account code and classification by Accountant.

Normally, this account is under selling expense or operating expense. The advertising expense is occurred when the Company needs to advertise their goods and service.

The Company has to seek for the advertising company that could provide the services. Contract for the advertising service is subjected to be made and sign as agreed by these two parties.

Auditor should obtain those contracts and summary it to get more understanding and their control on contract preparation. The audit procedure will be designed after the internal control is validated.

Assertions:

  • Completeness: To ensure the completeness of the advertising expenses account in the income statement, auditor has to obtain advertising schedule to reconcile with advertising contract listing. If there is discrepancy between these two listings, management’s explanation is required.
  • Accuracy: This assertion is concerning about the actual amount of the advertising expense which presented in the income statement well as in the advertising contract listing. It means that amounts and other data relating to transactions have been recorded at the correct amounts. For instance, amount appearing in the advertising contract is reflected to actual advertising expense amount to be paid to suppliers.
  • Existence: There are the risks that the advertising contract and schedule that the Company agreed with its suppliers (advertising service provider) might not be existed. Auditor should perform checking on the advertising contract by selecting some contract for vouching.
  • Presentation and Disclosure: This assertion concern the disclosure of important information that matters to the users of financial statements. Those include the accounting policy, significant contract, as well as authorized person who could sign on the contract.
  • Cut-off: One of assertion that auditor should focus on. If the cut-off is not properly check and perform, the amount of the advertising expense which presented in the income statement will be understated/overstated.

Common Risks Related to advertising expense audit:

Audit risks that related to advertising expense are different based on auditor understanding on its control, the nature of the expense and also the nature of the Company. The following are the risks that normally come up when perform an audit on the advertising expenses;

  • Discrepancy between balance per recording and its supporting document: It is important for auditor to perform test of detail by selecting some sample of the advertising transaction to check.
  • Significant variance between GL amount with TB amount of advertising expense account and its supporting documents and management could not explain to the auditor. In this case auditor needs to ensure that the variance is explained with proper acceptable explanation. There might be an omission of advertising expense transaction or accountant fails to post some transaction into the system.
  • Fictitious contract: The contract is prepared by unauthorized person and lead to financial loss of the Company. This indicated that the Company has no proper authorization matrix.

Audit Procedures:

  • Reconcile GL and trial balance (TB) of advertising expense account and with advertising contract listing (if any): Auditor should obtain financial statements for the period of auditing as well as relevant period. Before working on the GL of this expense, auditor should make sure that the GL and the TB are reconciled.
  • Testing by vouching through targeted or sampling testing over the working GL. Agreed to Contract is an important key done for the testing.
  • Perform analytical review on the advertising expenses that records in the current period compared to the previous period and check if the trend or variance is in accordance with the audit’s understanding of the client nature of business. The auditor should seek an explanation from the management of the company if the differences are sound unusual.