What is Journaling Entry Testing? Why Is It Important?

Journaling entry testing:

The need for journal entry testing arises when the auditor needs to test the nature, timing, and extent of journal entries. It is done to recognize the risk of material misstatement due to fraud while recording financial transactions.

The auditor should be vigilant in its audit of transactions and look at all suspicious nature transactions. The auditor should verify all the transactions with the supporting documents, and a higher authority should duly authorize all the entries after the accountant records the transactions.

During the audit, the auditor usually tests the sample transactions by following substantive procedures. He verifies the authenticity, validity, accuracy of the transactions.

During this procedure, he may cross-check the journal entries with the supporting documents, vouchers. Journal entry testing is carried out to have a proper understanding of the company’s internal control system.

 This testing also reflects on the compliance procedures adopted by the company in dealing with the established rules and standards of accounting and auditing.

The accountants prepare journal entries, so this testing should involve the inquiries of management and other staff, including the internal auditors, about fraud risks. Journal entry testing is carried out by the auditors who audit the financial transactions of the company.

Otherwise, the testing can be done for external requirements when a court or government orders a probe into the company’s financial transactions due to financial misconduct, fraud, and negligence.

Importance of Journal Entry Testing:

  • Data analysis in audits: Audit testing is carried out to gather sufficient and appropriate audit evidence. Without testing journal entries, the professional requirement for documentation and test of efficiency and effectiveness of the internal control system cannot be carried out. Data analysis has become a wide field to recognize the trend and is necessary for the success of the enterprise.
  • Maintains quality and efficiency: The volume of data used in companies is increasing manifold. These transactions are recorded in accounting packages. Hence it helps to increase the authenticity, validity, and accuracy of the transactions.  The journal entry testing ensures that all the postings are done in line with standards set by the organization and following all the audit and accounting standards.
  • Detects misstatements including fraud: This testing is done on sample entries and if any suspicion arises on such entries, the auditor goes through extensive audit procedures viz. compliance and substantive procedures to detect misstatements and frauds. The frauds when detected during journal entries testing mean that auditors need to expand their audit sample and, in some cases, extend to the whole of the population.
  • Test the appropriateness of the entries made: This testing is carried out to know whether the entries are authorized by the higher authority and the proper backing of such entries is available.
  • Test the existence, working of internal control system: Journal entry testing helps in detecting the existence, the efficiency of the internal control system. When the internal control system is functioning properly, the frauds cannot go unnoticed and it can be detected by maker and checker policy. Maker and checker policy basically mean a dual way of preparation of any accounting records and verification of the same by another accounting staff preferably of higher authority and qualification.
  • Used as evidence during forensic audits: When forensic audits are carried out to unearth the frauds in a company, journal entry testing can be used as evidence by the investigating agencies in trial proceedings. When it has been established in the journal entry testing that internal controls have been good, forensic audits can be conducted thoroughly and effectively and in line with guidance.
  • Helps to detect the inappropriate financial assertions: Financial assertions include completeness, cut-off, accuracy, occurrence, and classification. So, the recorded expense transactions should pass the above tests. When any lapses occur in relation to the above criteria, journal entry testing can trace those errors. The accountants may make mistakes as a result of ignorance or due to low knowledge of such aspects. Hence, the journal testing would help to remove such assertions but after the entries have been made.
  • Protects the company and its stakeholders from impacts of fraud: This testing helps to detect the lacunae in the internal control system and frauds in the accounting of the financial transactions. If frauds are detected at an early stage, the reputation of the company still remains intact. How it deals with these circumstances also ensures the survival and brand reputation of the organization.
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