AUDIT PROCEDURE FOR OBTAINING EVIDENCE

Tests of controls

Tests of controls are designed to evaluate the operating effectiveness of the audit client's controls at preventing, detecting and correcting material misstatements. [ISA 500, 4]

Examples of tests of controls:

? Inspect purchase invoices for evidence of authorization by a manager before payment is made.

? Observe the process for dispatch of goods to ensure the warehouse staff check the goods to the order before dispatch.

? Using test data, enter a dummy order over a customer's credit limit to verify that the system will not accept it.

Substantive procedures

Substantive procedures are designed to detect material misstatements (fraud and error) in the financial statements. Substantive procedures can be tests of detail or analytical procedures. [ISA 500, 4]

Substantive tests of detail look at the supporting evidence for individual transactions and traces them through to the financial statements to ensure they are dealt with appropriately.

Examples of tests of detail:

? Inspect a purchase invoice for the amount and trace it into the detailed purchase listing to ensure it has been recorded accurately.

? Recalculate an allowance for doubtful receivables using the client's formula to verify arithmetical accuracy.

Substantive analytical procedures test the balances as a whole to identify any unusual relationships e.g. comparison of a gross profit margin year-on-year might highlight that revenue is overstated if there is no known reason for an increase in the margin. An analytical procedure can be seen as a sense check of a balance or testing the 'reasonableness' of a balance.

Examples of analytical procedures:

? Calculate the receivables collection period and compare with credit terms offered to customers to identify any possible overstatement. If the collection period appears too high, discuss with management the need for an increase in the allowance for doubtful receivables.

? Obtain a breakdown of sales by month and analyze the seasonal trend to ensure it is consistent with the auditor's knowledge of the business. Discuss any unusual fluctuations with management.

? Calculate the expected interest charge for a loan by multiplying the outstanding loan amount by the interest rate and compare with the client's figure. Discuss any significant difference with management.

Source: Kaplan