Chapter 9 · Consider the impact of the audit findings on other accounts, fraud risk, and ICFR....

Chapter 9

Substantive Procedures and the

Financial Statement Audit

Prepared by Richard J. Campbell

Copyright 2011, Wiley and Sons

Learning Objectives

1. Recognize the audit associations of transaction cycles,

account balances, management assertions, and audit steps.

2. Understand the reasons an audit opinion is limited to

reasonable assurance.

3. Learn to draw conclusions from the results of audit tests of

account balances.

4. Understand the audit documentation appropriate for

substantive tests and procedures.

Chapter 9 -1

Learning Objectives

5. Become familiar with specific topics that are particularly

important to financial statement audits, for example,

estimation processes, going-concern considerations, and

period-end cutoff.

6. Learn the substantive tests and procedures that are

important for the various financial statement accounts.

Chapter 9 -2

TRANSACTION CYCLES AND ACCOUNT BALANCES

Learning Objective #1 Chapter 9 -3

Transaction cycles can be defined differently for different

businesses and industries, but generally most businesses

have a cycle dealing with

• Sales or sources of revenue and cash receipts

• Purchases or acquisitions and cash disbursements

• Human resources

• Production or inventory, which, when necessary includes

cost accounting

• Activities that are financing related, such as investment,

debt, and equity transactions

Substantive Procedures on Accounts and Disclosures

Chapter 9 -4 Learning Objective #1

EXHIBIT 9-1

MATERIALITY AND REASONABLE ASSURANCE


Sampling is used for tests of details of balances

Errors in audit tests and procedures are either

nonsampling or sampling errors

Sampling error can also occur on an audit when

the selected sample does not represent the

population

MATERIALITY AND REASONABLE ASSURANCE


Analytical Procedures, Fluctuation Analysis

Learning Objective #2 Chapter 9-7

EXHIBIT 9-2

Audit Risk Model


AR stands for audit risk

RMM is the risk of material financial

statement misstatement

IR stands for inherent risk

CR stands for control risk

DR stands for detection risk.

TD is the risk that a material misstatement will be

missed by the auditor’s tests of details of balances.

AP is the risk that a material misstatement is

missed by the audit’s analytical procedures

PERFORMING SUBSTANTIVE TESTS AND PROCEDURES


Auditors perform substantive tests using tests of details of

balances and substantive analytical procedures

A general description of the initial steps for a test of details

of balances using a sample is as follows:

1. Determine which account and assertion is being evaluated

2. Decide what audit procedure needs to be used to test the

assertion

3. Decide on the sampling method.

4. Decide on the sampling frame, or physical population from which

the sample is selected, and the sampling unit.

PERFORMING SUBSTANTIVE TESTS AND PROCEDURES (Part 2)


5. Determine the method to select the sample, such as utilizing

identifying numbers produced by a random number generator,

systematic sampling with a random start, or haphazard

sampling.

6. Determine the sample size needed.

7. Select the sample, perform the test, and identify discrepancies

8. Evaluate the sample results.

Conclusions as a Result of Substantive Tests and Procedures:

Evaluating Results

Steps to evaluate an account balance based on an audit test of

a sample are summarized as follows:

1. Determine the recorded amount of the sample.

2. Using evidence collected from the sample, investigate the

misstatements.

3. Using the sample as a basis, estimate the “true” account balance.

4. Set a tolerable misstatement

5. Evaluate whether the account balance is materially misstated and

requires an adjustment

6. Consider the impact of the audit findings on other accounts, fraud

risk, and ICFR.

Learning Objective #3 Chapter 9 - 11

Quantitative Evaluation of Sample Results


EXHIBIT 9-3

Quantitative Evaluation of Fishtrackers’ Inn Outcome


EXHIBIT 9-4

AUDIT DOCUMENTATION


Lead schedule is the term for the audit work

paper that lists and specifies the components

that make up the line item on the working trial

balance.

Detailed work papers support the information on

the lead schedule, providing information about

the audit tests performed on each component of

the trial balance line item and results of the tests.

Work Paper Examples


EXHIBIT 9-5

Work Paper Examples


IMPORTANT CONSIDERATIONS IN A FINANCIAL STATEMENT AUDIT


Estimates

Fair Value Measurements and Disclosures


Illegal Acts


Related Party Transactions


Going Concern


AREAS ADDRESSED IN A FINANCIAL STATEMENT AUDIT


Examples of Audit

Steps for Cash

EXHIBIT 9-6

AREAS ADDRESSED IN A FINANCIAL STATEMENT AUDIT


Receivables


Inventory


Investments, Emphasis on Marketable Securities


EXHIBIT 9-9

Investments, Emphasis on Marketable Securities


Current Payables


Examples of

Audit

Steps for

Accounts

Payable

EXHIBIT 9-10

Long-Term Debt


Examples of

Audit

Steps for Long-

Term

Debt

EXHIBIT 9-11

Long-Term Debt


SUMMARY OF SUBSTANTIVE TESTS AND PROCEDURES


APPENDIX A: STATISTICAL TECHNIQUES AND TESTS OF DETAILS

OF BALANCES

Appendix A Chapter 9-35

Characteristics

and

Sample Size

EXHIBIT A9-1


OF BALANCES

Chapter 9-36

Confidence

Coefficients

EXHIBIT A9-2

Appendix A


OF BALANCES


Results of the

Sample

and Audit Analysis

EXHIBIT A9-3

Review Question

Chapter 9-38

Which of the following audit processes will the auditor

have to wait until the end of the fiscal year, or after, to

perform?

(a) Observing the inventory count

(b) Testing the operating effectiveness of the yearend

closing and reporting process

(c) Inquiring of the client and identifying related parties

(d) Evaluating the possibility of illegal acts

Review Question

Chapter 9-39

Regarding illegal acts, which of the following

is not true?

(a) The auditor is more likely to become aware of illegal acts that

have a direct impact on the financial statements.

(b) The auditor does not have to follow up on

material illegal acts that he or she becomes

aware of as long as they do not have a direct

effect on the financial statements.

(c) Illegal acts are one of the topics that is covered in the

management representations letter.

(d) All of the above are true.

Review Question

Chapter 9-40

Which of the following is not important to

the auditor regarding related party

transactions?

(a) Adequacy of disclosure of material

related party transactions

(b) Material misstatement of any of the

transactions because they are not arms

length

(c) Identifying all the related parties so that

the related party transactions and financial

statement disclosure can be evaluated

(d) All of these are important to auditing

related party transactions.

Copyright

“Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.”

Chapter 9 · Consider the impact of the audit findings on other accounts, fraud risk, and ICFR....

Documents

Transcript of Chapter 9 · Consider the impact of the audit findings on other accounts, fraud risk, and ICFR....