How substantive audit procedures are performed by the auditor in an audit of financial statements?

What are Substantive Procedures?

Substantive procedures are the method or audit tests designed by an auditor to evaluate the financial statements of the company, which require an auditor to create conclusive evidence for verifying the completeness, accuracy, existence, occurrence, measurement, and valuation (audit assertions) of the financial records of the business.

Inhaltsverzeichnis Show

• What are Substantive Procedures?
• Explanation
• Example of Substantive Procedure
• Substantive Procedure for Account Transactions
• Recommended Articles
• What substantive audit procedures should be performed?
• What are substantive procedures and at which stage of audit is it performed?
• How do you perform a substantive audit test?
• When planning substantive audit procedures What should the auditor do?

Explanation

The intention behind performing the Substantive procedures by an auditor is to check that there is no material misstatement in the business’s financial records, i.e., they are complete, accurate, valid, and all the material information is disclosed. The method followed includes testing the account balances, examining the general entry, and other adjustments made while preparing the company’s financial statementFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more. It also includes making inquiries about suspicious transactions. Some examples can be external party confirmation like confirming the company’s bank balance from the Bank directly, performing a physical inventory count, confirming Accounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read moreaccounts payableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more from creditors of the business, etc.

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1. Auditing I: Conceptual Foundations of Auditing
2. Auditing II: The Practice of Auditing

Example of Substantive Procedure

For example, there is a company named BSR Trading, whose financial statements of the company show the following balances:

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Source: Substantive Procedure (wallstreetmojo.com)

1. Cash balance of $2,500
2. The bank balance of $6,000
3. Accounts receivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more balance of $10,000
4. Trade payable balance of $8,000
5. InventoryDirect material inventory, work in progress inventory, and finished goods inventory are the three types of inventories. The raw material is direct material inventory, work in progress inventory is partially completed inventory, and finished goods inventory is stock that has completed all stages of production.read more of $5,000

Now the substantive procedures that can be followed on the above balances are:

1. The physical verification of the cash balance is to be done to check that the balance is accurate.
2. To verify a bank balance of $6,000, the auditor shall send written mail to the bank of the client to confirm that the client’s balance in the books of a bank is the same as that in the account books of the client. If there are any discrepancies, the bankA reconciliation statement contains a list of differences between bank balance as per bank statement, books of accounts, debtor-creditor reconciliation, debt balance reconciliation, or any other reconciliation with a difference in the records of two separate legal entities, and it aims at nullifying the difference.read more reconciliation statementA reconciliation statement contains a list of differences between bank balance as per bank statement, books of accounts, debtor-creditor reconciliation, debt balance reconciliation, or any other reconciliation with a difference in the records of two separate legal entities, and it aims at nullifying the difference.read more is to be prepared. If any differences still exist, the auditor should inquire to find out the difference.
3. For account receivable balances, the sales invoices should be verified, and also the debtors can be asked to confirm their balances.
4. For Trade Payable balances, the purchase invoices should be verified, and also the Creditors can be asked to confirm their balances.
5. To check the balances of inventory purchases, invoices, and sales invoices, should be verified, and the physical counting of inventory should be done.

Types

There are two types which are as follows:

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Source: Substantive Procedure (wallstreetmojo.com)

#1 – Test of Details

Test of details refers to collecting evidence that helps evaluate the correctness of the account balances, disclosures, and other accounting transactions made by the business entity in their financial statements.

#2 – Substantive Analytical Procedures

Analytical procedures are an important method performed while conducting the process of auditing. In the analytical procedures, the evaluations are made on the financial statements by studying the plausible relationships between financial and non-financial data. For example, computation of ratios, comparing past year balances with the current year, etc.

Substantive Procedure for Account Transactions

It followed to check the purchases of the raw material of the business:

1. Firstly, the purchase orders and the respective invoices should be verified, and then the invoices are to be matched with the GRN (goods receipt notes) to check that the respective goods have been received for every purchase invoice.
2. Rates and the quantity purchased in theA Purchase Order (PO) serves as a legal document between buyer and seller, wherein, the buyer sends this contract that details the goods and services, date of delivery, payment terms as per the contract etc.read more purchase orderA Purchase Order (PO) serves as a legal document between buyer and seller, wherein, the buyer sends this contract that details the goods and services, date of delivery, payment terms as per the contract etc.read more should be the same as the purchase invoice.
3. Then the posting of items received in the relevant ledger accounts should be verified.
4. Then the cut-off procedures on the purchases should be performed.
5. Last but not least, the analytical procedure is to be performed by comparing the purchase trends of last year with the current purchases, and if there is a major difference in the trend, then the reasons for such difference should be found.

The substantive procedure followed to check the Related party transactionRelated party transaction is an arrangement between two related parties for the transfer of resources, services or obligations, irrespective of whether a price is charged or can affect the statement of profit or loss and the financial position of an entity.read more of the business:

1. The transactions with the related parties are important. These transactions have more chances of inaccuracy because they are with the parties that are related to the owners/ directors of the company.
2. The auditors should obtain the relevant evidence to check these transactions’ nature, purpose, and extent. Also, it should be evaluated that these transactions are at an arm’s-lengthAn arm's length transaction is one in which two parties operate independently and the price agreed between them (also known as the transfer price) is free of any influence.read more price.

Importance

The substantive procedure is important to check the accuracy & completeness of a business transactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements.read more, measurement & valuation of an asset or liability of that business, and check that all material items are disclosed properly, etc. These procedures are important while conducting the audit to comment upon the truth and fairness of the company’s financial statements. It assures the following assertions to the auditorAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws.read more:

1. The existence of assets and liability on the given date.
2. The assets reported must be owned by the company on the given date.
3. The liabilities reported must be the company’s obligations to pay on the given date.
4. All the assets and liabilities that existed should be appropriately valued and recorded in the company’s financial statements.
5. Events or recorded transactions must be related to that auditing period only.
6. The transaction is recorded at the correct amount, and only those expenses and revenues are recorded that pertain to that period.

Conclusion

Substantive audit procedures are tests designed to collect evidence about the business transaction. The occurrences, validity, and existence of the transaction can be verified, and the accuracy of their accounting treatment can be checked.

Recommended Articles

This has been a guide to what is a substantive audit procedure. Here we discuss examples of such audit tests on accounting transactions and their types. You may learn more about finance from the following articles –

• Audit Test
• Purpose of An Audit
• Financial Audit
• Social Audit