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700.3 This chapter discusses substantive procedures and considerations specific to designing and performing
substantive procedures for a CIRA audit. Chapter 8 discusses the general procedures that are necessary during the concluding phase of the audit.
700.5 The authoritative
pronouncements establishing requirements that most directly affect
designing substantive procedures are as follows:
- a. SAS No. 56 (AU 329), Analytical Procedures, explains the use of analytical procedures as substantive tests to obtain sufficient appropriate audit evidence.b. SAS No. 99 (AU 316), Consideration of Fraud in a Financial Statement Audit,
- requires the auditor to identify and assess risks of material
- misstatement due to fraud, and to design the audit to provide reasonable
- assurance of detecting fraud that results in the financial statements
- being materially misstated.c. SAS No. 103 (AU 339), Audit Documentation,
- requires the auditor to document the work performed, the audit evidence
- obtained and its source, and the conclusions reached. In addition, it
- establishes other documentation requirements that need to be considered
- when designing audit programs and substantive procedures.d. SAS No. 106 (AU 326), Audit Evidence, describes audit procedures used to obtain audit evidence.e. SAS No. 110 (AU 318), Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained, addresses audit procedures that are responsive to risks at the relevant assertion level.
Substantive Procedures Required in Every Audit700.6
Because of the judgmental nature of the auditor's risk assessments and
the inherent limitations of internal control, particularly the risk of
management override, the auditing standards prescribe certain
substantive procedures that should be performed in every audit.
700.7 SAS No. 110 (AU 318.52) requires the auditor to perform the following substantive procedures in every audit:
• Agree the financial statements, including the accompanying notes, to the underlying accounting records.• Examine material journal entries and other adjustments made during the course of preparing the financial statements
700.8 SAS No. 99 (AU 316)
also requires certain substantive procedures in all audits to address
the risk of management override of controls. These required procedures
are as follows:
• Examining journal entries and other adjustments for evidence of possible material misstatement due to fraud (AU 316.58-.62).• Reviewing accounting estimates for biases that could result in material misstatement due to fraud (AU 316.63-.65).• Evaluating the business rationale for significant unusual transactions (AU 316.66).
700.9 Both SAS No. 110 and No. 99
require examining journal entries and other adjustments, but the
requirement of SAS No. 99 is focused on
identifying fraudulent journal entries
700.10 There are also other SASs
that impose presumptively mandatory requirements for substantive
procedures for particular account balances. Examples include the
- • Confirmation of accounts receivable. (AU 331.34)•
- Inventory observation, that is, being present at the time of the count
- and, by suitable observation, tests, and inquiries being satisfied
- about the effectiveness of the methods of inventory taking. (AU 331.01)
In addition, there are other specific requirements to perform procedures, typically called general procedures
that do not relate to particular account balances, such as sending a letter of audit inquiry to the client's lawyer.
700.12 SAS No. 110 (AU 318.77) requires the auditor to document the following items relating to substantive procedures:
• The nature, timing, and extent of substantive procedures.• The linkage of those procedures with the assessed risks at the relevant assertion level.• The results of the procedures.
700.13 Considering the Sufficiency and Appropriateness of Audit Evidence
Even if the auditor concludes that the risk of material misstatement
is low for a particular assertion related to a material account balance,
transaction class, or disclosure based on performing risk assessment
procedures and tests of controls, some
- substantive procedures are still
- required. The additional substantive procedures that are needed in
- particular circumstances depend on the auditor's judgment about the
- sufficiency and appropriateness of audit evidence in the circumstances.
SAS No. 106 (AU 326.06) describes these characteristics of audit evidence as follows:
- • Sufficiency is the measure of the quantity of audit evidence.• Appropriateness is the measure of the quality
- of audit evidence, that is, its relevance and its reliability in
- providing support for, or detecting misstatements in, the classes of
- transactions, account balances, and disclosures and related assertions
700.14 The auditor performs risk
assessment procedures to obtain an understanding of the CIRA and its
environment, including its internal control, to assess the risks of
material misstatement. This assessment includes consideration of the
effectiveness of management's responses and controls to address risks.
- The auditor evaluates the quality
- and quantity of the evidence obtained from the risk assessment
- procedures and, if applicable, tests of controls to determine the
- further audit procedures necessary to obtain sufficient appropriate
- evidence to afford a reasonable basis for expressing an opinion on the
- financial statements.
700.15 An important quality of
audit evidence is its reliability, which is affected by both the nature
and source of the evidence. SAS No. 106 (AU 326.08) provides the following generalization about the reliability of audit evidence:
- a. Audit evidence is more reliable when it is obtained from knowledgeable independent sources outside the entity.b. Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective.c.
- Audit evidence obtained directly by the auditor (for example,
- observation of the application of a control) is more reliable than audit
- evidence obtained indirectly or by inference (for example, inquiry
- about the application of a control).d. Audit evidence
- is more reliable when it exists in documentary form, whether paper,
- electronic, or other medium. For example, a contemporaneously written
- record of a meeting is more reliable than a subsequent oral
- representation of the matters discussed.e. Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or faxes.
Choosing between Analytical Procedures and Substantive Tests of Details700.16
The authoritative literature does not explain how to apportion
reliance on substantive procedures between tests of details and
analytical procedures except
- when testing significant risks, as discussed in paragraph 700.11.
- Analytical procedures may be used to reinforce conclusions based on the
- results of other substantive procedures or as the sole source of
- evidence. That decision is primarily based on the effectiveness of the
- procedures. Efficiency also may be a factor in deciding between
- analytical procedures and substantive tests of details. That is, given
- two procedures of equal effectiveness, the auditor chooses the one that
- is most efficient. Therefore, the auditor would ordinarily use an
- analytical procedure rather than a test of details if the analytical
- procedure is at least as effective in reducing detection risk to the
- desired level as the test of details and is easier to apply
700.17 Generally, the higher the
assessed risk of material misstatement, the more effective analytical
procedures need to be to produce higher reliance than tests of details.
Accordingly, auditors tend to use tests of details
- more extensively in high risk
- audit areas (such as areas containing fraud risks or other significant
- risks) and analytical procedures more often in low risk areas or as
- secondary rather than primary auditing procedures
However, if the auditor has highly
effective analytical procedures, it may be possible to reduce the
extent of detail testing needed, even in areas where significant risks
exist. The effectiveness of substantive analytical procedures in
reducing detection risk in comparison with the effectiveness of tests of
details generally depends on the facts and circumstances. However, the
following are some general observations:
- a. Analytical procedures are
- generally not effective in testing assertions about rights or
- obligations or assertions related to presentation and disclosure because
- those assertions do not lend themselves to testing through comparisons
- with expectations. Therefore, analytical procedures would not be
- effective responses for risks related to matters such as parties to
- transactions lacking in economic substance or intentional ambiguity in
- financial statement disclosures.
b. Relationships involving
- transactions over a period of time
- (that is, revenue and expense accounts) tend to be more predictable than
- relationships at a point in time (that is, balance sheet accounts).
- Because of the difficulty in developing expectations about a balance at a
- point in time with sufficient precision, analytical procedures are
- often not as effective as tests of details for assertions about the
- existence of assets and liabilities. Therefore, analytical procedures
- would not be as effective as tests of details when responding to risks
- such as recording false receivables or including items in inventory that
- are false or mislabeled
c. Analytical procedures
- are often equally or more effective
- than tests of details for assertions about the completeness of assets,
- liabilities, revenues, and expenses. When testing for completeness,
- misstatements would often not be apparent from inspecting detailed
- evidence in the accounting records.
d. Analytical procedures
- are often equally or more effective
- than tests of details for assertions about the occurrence of revenues.
- For example, comparing recorded revenue with the amount expected, based
- on a reliable record of member units and average assessments, may be as
- likely to detect a material misstatement of assertions about the
- occurrence of revenues as inspecting supporting documentation for a
- sample of recorded revenue. Analytical procedures are more reliable if
- they are based on reliable data produced outside the accounting system
- (for example, approved assessment cost per unit or operating data used
- to manage the CIRA).
e. Analytical procedures are often equally or more effective
- than tests of details for
- assertions about the occurrence of certain expenses. For example,
- comparing recorded labor costs with the amount expected, based on the
- number of people employed and the average hours worked, may be as likely
- to detect a material misstatement resulting from errors as looking at
- supporting documentation for a sample of recorded compensation expense.
- However, if fraud is a concern, analytical procedures may not be
- effective. For example, if management is able to manipulate expense
- accounts so that ratios appear reasonable, ratio analysis would not be
- an effective analytical procedure for detecting material misstatements.
f. Analytical procedures may be as effective as tests of details for assertions
- about the valuation of some assets
- and liabilities but not for others. Generally, whether an analytical
- procedure is as effective as a test of details for a valuation assertion
- depends on whether an expectation can be developed. For example, an
- analytical procedure may be as effective as a test of details for
- assertions about the valuation of member receivables that are made up of
- a large number of relatively small balances. However, a test of details
- may be more effective when some account balances are disproportionately
- large. In that situation, failure to record an allowance for
- uncollectible amounts resulting from a deterioration in the financial
- condition of one of those members either before or after year-end would
- most likely not be detected by an analytical procedure
g. Substantive tests of details may be more effective for
- valuation assertions in an unstable
- environment. The ability to develop an expectation that approximates
- the recorded amount is greater when the environment is stable. For
- example, when interest rates are fluctuating widely, it is difficult to
- develop a precise expectation about interest expense. Similarly, when
- transactions involve management discretion, such as the choice of
- repairing versus replacing equipment, there is also less predictability
- in relationships.