Wednesday, January 13, 2010

Nature of audit tests

Decision about the nature of audit test are related to the auditors choices about the type of evidence that they collect to support an opinion. There are three common type of audit procedures :

- Risks assesment procedures that are designed to help the auditor assess the risk of material maisstatement in an assertion, wether performed early in the audit engagement or in the response to new information. Recall that the auditor uses risk assessment procedures to obtain evidence about inherent risks and the risk of fraud.

- Test of Control that are designed to provide evidence about the operating effectiveness of various aspect of internal control. Tests of control provide evidence to support control risk assessment below the maximum.

- Substantive test that are designed to provide evidence about to fair presentation of management's assertions in the financial statements. Substantive test include :

1. Initial procedures that involve understanding the economic substance of the account balance or transaction being audited and agreeing on detailed information about an account to general ledger (such as comparing an accounts receivable subsdiary ledger to the general ledger)

2. Substantive analytic procedures that involve the use of comparisons to assess the fairness of an assertion. For example, the auditor might evaluate sales per square foot or retail space in testing the reasonableness of revenues.

3. Test of detail transactions that involve examining documentary support for transactions. For example, an auditor might inspect sales orders and a bill of landing behind a recorded sales invoice.

4. Test of details of balance that involved examining support for a general ledger balance. For example, the auditor might send confirmations to customers to obtain an evidence that they owe receivables.

5.  Test of detail accounting estimates that involve obtaining evidence in support of the client's estimations process and ensuring that the estimation process is applied consistently from period to period.

6. Test of details of disclosures that involve examining support for financial statement disclosures. For example, the auditor might read a loan contract to ascertain the maturity schedule and debt covenants for the loan

Substantive test provide the evidence that allows the auditor to achieve the desired detection risk and ensure that overall audit risk and ensure that overall audit risk is reduced to an appropriately low level.
Recall the risk assessment, for example. For assertion 1, the existence of inventory, the nature of auditor's evidence would include significant test of controls (testing of effectiveness of the client's perpetual inventory system) as well as some limited substantive test (direct observation of inventory). For assertion 2, the valuation of inventory, auditor would perform few test of controls because controls are not expected to be effective. However, the auditor would plan to obtain significant evidence by testing the pricing of inventory to underlying vendor's invoices (substantive test of balances). In addition, the auditor would obtain evidence about sales price after years-end to support a conclusion about the lower of cost of market objective (substantive test of an accounting estimate). 

18 comments:

Anonymous said...

Very helpful... thanks :)

Anonymous said...

Really helpful, clear explanation! thank you :)

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iacrecruit said...

Really helpful. I think audit test should be done by every firm. So that auditor will have smooth work.

peterson said...

Your article is really informative. Thanks for sharing this details.

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peterson said...

Your article is really informative. Thanks for sharing this details.

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