CHAPTER 12 Audit Strategy in Response to Assessed Risks Fall 2007 u Designing Substantive Tests u Special Consideration in Designing Substantive Tests.
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CHAPTER 12CHAPTER 12
Audit Strategy in Response to Audit Strategy in Response to Assessed RisksAssessed Risks
Fall 2007Fall 2007
CHAPTER 12CHAPTER 12
Audit Strategy in Response to Audit Strategy in Response to Assessed RisksAssessed Risks
Fall 2007Fall 2007
Designing Substantive Tests Special Consideration in
Designing Substantive Tests
Designing Substantive TestsDesigning Substantive Tests
In each audit, there are certain substantive procedures that must be performed:
1. Initial procedures2. Analytical procedures3. Tests of details of transactions4. Tests of balances including estimates5. Tests of disclosures
Initial ProceduresInitial Procedures
Before doing any detailed testing:• Economic substance of transactions• Consistency of accounting principles applied• “Tie out” beginning balances and detailed
records
How do we do each of these?
Recall the AR ModelRecall the AR Model
AR = IR x CR x AP x TD
When do we focus on each category of substantive tests?– Analytical procedures– Tests of transactions– Tests of balances
Use:- Top-down:to identify areas of greater risk of misstatement
and identify where need to do more tests of details - In testing phase: as a substantive test of a balance
Fundamental Assumption: - Relationships are expected to persist in absence of
information to the contrary
Effectiveness and efficiency depends on:- Nature of the assertion- Plausibility and predictability of the relationship- Availability reliability of data used to develop expectation- Precision of the expectation
Analytical ProceduresAnalytical ProceduresAnalytical ProceduresAnalytical Procedures
Analytical Procedures cont’dAnalytical Procedures cont’dAnalytical Procedures cont’dAnalytical Procedures cont’d
Examples:- Ratio analysis
- Comparisons with prior year- Comparisons with industry data
- Common sized analysis- Budget to actual- “Reasonableness tests”
- Depreciation expense- Amounts based upon contractual obligations- Use of non-financial metrics: # subscribers, ticket
sales, miles flown, etc.
Use:-Bottom up test of individual transactions and the related journal entries-Generally involve tracing and vouching-May involve a sample to reach conclusion about an account balance
Fundamental Assumption: -If the transactions are appropriate, then the acct balance is too
Examples-Vouch recorded sales & AR to source documents-Trace shipments to Sales journal-Examine certificates of title for PPE additions
Tests of Details of Tests of Details of TransactionsTransactions
Tests of Details of Tests of Details of TransactionsTransactions
Tests of Details of BalancesTests of Details of BalancesTests of Details of BalancesTests of Details of Balances
Use:- Bottom up test of individual account balances rather
than individual debits and credits- Sampling can be used to draw a conclusion about the
whole balance
Fundamental Assumption: - Effectiveness depends upon the procedure performed &
evidence obtained
Examples not related to estimates- Obtain bank confirmation- Recalculate accrued interest expense- Count ending inventory
Tests Balances: EstimatesTests Balances: EstimatesTests Balances: EstimatesTests Balances: Estimates
What is an “accounting estimate”?- Amount uncertain, pending future events- Event already occurred, but can’t be easily determinedFundamental Assumption- Management responsible for making estimate- Auditor responsible for auditing itHow to audit an estimate (SAS 57)- Consider relevant economic, industry & co factors- Understand how management develops estimate- Evaluate reasonableness of estimate
- Review and test the process used by management - Develop an independent expectation of the estimate to
corroborate the reasonableness of management's estimate.
- Review subsequent events or transactions
Tests of DisclosuresTests of Disclosures
• Think about the appropriate footnotes• Read text for consistency with your
understanding of the transactions and accounting policies
• Test any “numbers”• Related party transactions• Use disclosure checklist
Related Party TransactionsRelated Party Transactions
Responsibilities• Consider need for disclosure
• Understand business purpose • Examine supporting documents• Test for approval by BOD• Consider need for coordination with audits
of other party
More evidence is needed to achieve a low acceptable level of detection risk than a high detection risk.
“Extent” is used in practice to mean the number of items or $ as a percentage of total to which a particular test or procedure is applied. This generally involves sampling.
Extent of Substantive TestsExtent of Substantive TestsExtent of Substantive TestsExtent of Substantive Tests
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