1. Types of tests
Risk Assessment Procedures – Auditors use the results of risk assessment procedures to determine the type and amount of further audit procedures necessary to form an opinion on the fairness of the financial statements.
Further audit procedures include:
Tests of controls
Substantive tests of transactions
Substantive analytical procedures
Tests of details of balances
Further Audit Procedures and the Audit Risk Model are shown in Figure 13-1.
After the auditor assess the risk of misstatement in the financial statements, the auditor must decide the type and amount of further testing to do.
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3. Types of tests (cont.)
Tests of Controls – To obtain sufficient appropriate evidence to support a reduced assessment of control risk, the auditor:
Make inquiries of appropriate client personnel
Examine documents, records, and reports
Observe control-related activities
Reperform client procedures
The amount of evidence needed for tests of controls depends on two things:
The extent of evidence obtained in gaining the understanding of internal control
The planned reduction in control risk
The role of tests of controls is shown in Figure 13-2.
Table 13-1 identifies a test of control that might be performed to test its effectiveness.
The auditor may test controls to determine if internal control can be relied upon, to reduce the amount of other testing.
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4. Types of tests (cont.)
Substantive Tests of Transactions – Used to determine whether all six transaction-related audit objectives have been satisfied for each class of transactions.
Substantive Analytical Procedures - Although not required, substantive analytical procedures may be used to audit an account balance. The two most important purposes of substantive analytical procedures are:
Indicate possible misstatements in the financial statements
Provide substantive evidence
Tests of Details of Balances – The primary emphasis of tests of balances is on the balance sheet.
Summary of Types of Tests - Figure 13-2 summarizes the types of tests the auditor may use.
Besides testing controls, the auditor may use any combination of substantive tests to satisfy the audit objectives.
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5. Selecting which Types of tests to perform
Availability of Types of Evidence for Further Audit Procedures –Each of the four types of further audit procedures involves only certain types of evidence.
The relationship between further audit procedures and the types of evidence are summarized in Table 13-2.
Relative Costs – The auditor must decide which type of test to select for obtaining sufficient appropriate evidence and the cost of the evidence is an important consideration. Types of tests in order of increasing cost:
Substantive analytical procedures
Risk assessment procedures
Tests of controls
Substantive tests of transactions
Tests of details of balances.
Selecting the type of tests to perform depends on what audit objectives are involved and must be balanced with the relevance vs. the cost of the testing.
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7. Selecting which Types of tests to perform (cont.)
Relationship Between Tests of Controls and Substantive Tests – When test of controls show deviations that lead the auditor to believe that there may be material misstatements, the auditors then perform substantive tests to determine whether a material misstatement actually occurred. Relationship Between Substantive Analytical Procedures and Other Substantive Tests - Analytical procedures only indicate the likelihood of misstatement. Unusual fluctuations indicate an increase in the likelihood. Trade-Off Between Tests of Controls and Substantive Tests – During planning, auditors decide whether to assess control risk below the maximum. If they do, they must test the controls. This is shown in Figure 13-3.
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9. Evidence mix
The types of evidence chosen and the extent of use by the auditor varies widely from audit to audit, based on levels of internal control effectiveness and inherent risks.
The combination of the types and amounts of evidence needed in an audit is referred to as the evidence mix.
Four different audit scenarios are shown on page 418, giving information about the internal control effectiveness, size of the company and other factors. The evidence mix for each of these scenarios are shown in Table 13-3.
The mix of what types of evidence the auditor gathers depends of the effectiveness of internal controls and inherent risks involved with the class of transaction or account balance that is in question.
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11. Design of the audit program
The auditor uses risk assessment procedures to determine the appropriate emphasis on each of the other four types of tests, and design the specific audit procedures for each type of test. These audit procedures are combined to form the audit program.
The audit program will include procedures to satisfy all audit objectives, but here we focus on designing audit programs to satisfy transaction- related and balance-related audit objectives.
Besides the risk assessment procedures, the audit program is designed in three additional parts:
Tests of controls and substantive tests of transactions
Substantive analytical procedures
Tests of details of balances
The design process is shown in Figure 13-4.
Auditing standards require an written audit program, which is a plan for the audit.
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13. Design of the audit program(cont.)
Tests of Controls and Substantive Tests of Transactions – When designing these tests, auditors emphasize satisfying the transaction-related audit objectives.
Auditors follow a four-step approach to reduce assessed control risk:
Apply the transaction-related audit objectives to the class of transactions being tested, such as sales.
Identify key controls that should reduce control risk for each transaction-related audit objective.
Develop appropriate tests of controls for all internal controls that are used to reduce the preliminary assessment of control risk below maximum (key controls).
For potential types of misstatements related to each transaction-related audit objective, design appropriate substantive tests of transactions, considering deficiencies in internal control and expected results of the tests of controls in step 3.
This process is shown in Figure 13-5.
Designing tests to include in the audit program emphasizes satisfying the audit objectives of the transaction class or account balances.
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15. Design of the audit program(cont.)
Substantive Analytical Procedures – Because substantive analytical procedures are relatively inexpensive, many auditors perform them on all audits.
Tests of Details of Balances – The key decisions involved in designing tests of details of balances:
Identify Significant Risks and Assess Risk of Material Misstatement
Set Performance Materiality
Assess Control Risk for the Sales and Collection Cycle
Design and Perform Tests of Controls and Substantive Tests of Transactions
Design and Perform Substantive Analytical Procedures
Design Tests of Details of Accounts to Satisfy Balance-Related Audit Objectives
This methodology is shown in Figure Overall design approach is shown in Figure 13-7.
Tests of details of balances involves the key decisions shown on this slide.
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18. Design of the audit program(cont.)
Level of Disaggregation of Planning Activities– The levels range from overall audit to balance-related audit objectives.
An example of the Disaggregation Level to Which Planning Activities Are Applied is illustrated in Figure 13-8 on page 425.
Illustrative Audit Program - Auditing standards require the auditor to use a written audit program.
An audit program for Tests of Details of Balances for Accounts Receivable is shown in Table 13-4 on page 427.
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19. Relationship of transaction-related audit objectives to Balance-related and Presentation and disclosure-related audit objectives
Tests of details of balances are the primary test to reduce detection risk to an acceptable level.
Even when all transaction-related audit objectives are met, the auditor will still rely primarily on substantive tests of balances to meet the following balance-related audit objectives:
Realizable value
Rights and obligations
These relationships are illustrated in Table 13-5.
Balance-related and disclosure-related tests emphasize the realizable value and the rights and obligations the client has.
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21. Summary of key evidence-related terms
Phases of the Audit Process – The four phases are shown in the first column of Table Audit Objectives – The objectives that must be met before the auditor can conclude that any given class of transactions or account balance is fairly stated, shown in the second column of Table Types of Tests – The five types of audit tests are shown in the third column of Table Evidence Decisions – The four subcategories of decisions are shown in the fourth column of Table Types of Evidence – The eight broad categories of evidence are shown in the last column of Table 13-6.
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23. Summary of the audit process
Phase I: Plan and Design an Audit Approach
Phase II: Perform Tests of Controls and Substantive Tests of Transactions
Phase III: Perform Substantive Analytical Procedures and Tests of Details of Balances – Timing of Tests is shown in Table 13-7
Phase IV: Complete the Audit and Issue an Audit Report:
Perform Additional Tests for Presentation and Disclosure
Accumulate Final Evidence
Issue Audit Report
Communicate with Audit Committee and Management
The Summary of the Audit Process is illustrated in Figure 13-9 on page 430.
There are four phases to the audit process.
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