Substantive Audit Programs

1. Substantive Audit Programs Chapter 15 Auditing Fundamentals Lee Homewood

2. Learning Outcomes List substantive tests of transactions and balances for various subsystems. Design substantive tests for various subsystems. 2

3. SUBSTANTIVE AUDIT PROGRAMS The substantive test for each subsystem must: - relate to the transactions and balances of that subsystem - be able to support the amount presented in the financial statements. The audit program also allows for: - the exploration of the audit trail, - performance of analytical reviews, - the dissection of the profit and loss statement, cash flow statement and balance sheet. 3

4. SUBSTANTIVE AUDITS TEST FOR SALES SUBSYSTEM Select a number of entries in the Sales Journal (SJ) and vouch to source documents (sales invoice) Trace a number of sales invoices to the SJ and ledger accounts Verify arithmetic accuracy of sales invoice and SJ Review SJ for large or unusual items Perform year-end cut-of test and prepare adjusting entries Review presentation of sales in the financial statements 4

5. SUBSTANTIVE AUDIT TESTS FOR PURCHASES SUBSYSTEM Select a number of entries in the Purchases Journal (PJ) and vouch to source documents Trace a number of supplier invoices to the PJ and ledger accounts Perform recalculations on supplier invoices Review the PJ for large or unusual items Perform year-end cut-of test and prepare adjusting entries 5

6. SUBSTANTIVE AUDIT TESTS FOR  ACCOUNTS RECEIVABLE SUBSYSTEM Verify Accounts Receivable Trial Balance figure and reconcile to General Ledger account and subsidiary ledgers. Confirm Accounts Receivable - Letters are sent to various debtors asking them to confirm the balance as at 30 June. - Positive confirmations are used where the debtor is asked to respond if they agree with the balance as well as if there is a difference. Vouch accounts receivable entries in accounting records to source documents Review an aged analysis of debtors and check for debtors to 120 days. Review adequacy of Provision for Doubtful Debts Perform Sales cut-off tests 6

7. SUBSTANTIVE AUDIT TESTS FOR ACCOUNTS PAYABLE SUBSYSTEM Verify accuracy of accounts payable trial balance figure and reconcile to creditors� balances subsidiary and general ledger Vouch recorded creditors to supporting documentation Confirm creditors - Confirmation letters sent out to creditors. Letters are sent to various creditors asking them to state the balance as per their records as at 30 June. - Positive confirmations are used. Perform purchases cut-off tests Perform cash payments cut-off tests 7

8. SUBSTANTIVE AUDIT TESTS FOR CASH RECEIPTS AND PAYMENTS SUBSYSTEM Confirm bank and loan balances with the bank Count cash on hand Prepare independent bank reconciliation Perform cash cut-off tests Review prepayments The testing of this subsystem includes all cash and related cash items such as:- term deposits, trust accounts credit cards, EFT, petty cash and cash floats 8

9. SUBSTANTIVE AUDIT TESTS FOR  NON-CURRENT ASSETS SUBSYSTEM Verify accuracy of fixed asset register and agree fixed assets register with property, plant and equipment balances Ensure correct depreciation rates have been used Recalculate depreciation and accumulated depreciation Inspect property, plant and equipment additions Vouch property, plant and equipment additions to register Vouch property, plant and equipment disposals/trade-ins to register Examine title or lease documents Inspect Repairs & Maintenance expense entries to ensure correct allocation 9

10. SUBSTANTIVE AUDIT TESTS FOR  INVENTORY SUBSYSTEM Verify accuracy of schedules and perpetual records and agreement with inventory balances Observe client inventory taking � be present at the client�s stocktake Vouch recorded purchases to supporting documentation Enquiry of management regarding ownership Review inventory pricing, valuation and data relating to inventory quality 10

11. SUBSTANTIVE AUDIT TESTS FOR  PAYROLL SUBSYSTEM Review payroll records and recalculate payroll Recalculate accrued wages Select a sample of transactions from the payroll register and vouch to the journal entries and general ledger Verify payroll calculations Review preparation of payroll tax and deductions Review management bonuses remunerations 11

12. SUBSTANTIVE AUDIT TESTS FOR  INVESTMENTS SUBSYSTEM Send out Confirmation Letters to confirm balances Verify accuracy of balances, schedules and Investment Register Inspection of documentation � broker invoices, remittance advice for dividend income received and/or interest earned Vouch entries in investment accounts Recalculate interest earned Review closing values of investments to market conditions 12

13. SUBSTANTIVE AUDIT TESTS FOR LONG-TERM LIABILITIES SUBSYSTEM Send out Confirmation Letters to confirm long-term debt Review documentation � debt authorisation and contracts and vouch to entries in accounting records. Analytical review Review interest expense calculations 13

14. SUBSTANTIVE AUDIT TESTS FOR  SHAREHOLDERS� FUNDS SUBSYSTEM Inspect Share Register Vouch entries to share capital accounts, retained profits and reserves Review Constitution of the company Check the share and equity issues have adhered to Corporations Law and other relevant legislative or technical requirements. Check that dividends are properly authorised. 14

15. SUBSTANTIVE AUDIT TESTS FOR  CONTINGENT LIABILITIES SUBSYSTEM A contingent liability is where an event may/may not occur in the future, that is material to the current financial statements and the audit. i.e. Legal action that has not yet been finalised Subsequent events are also considered which have a material impact on the financial statements. i.e. Loss of a production for a substantial period of time due to an �Act of God� Review should be carried out of:- directors minutes, insurance policies, leases, loan agreements, legal papers, foreign exchange rates, etc 15

16. SUBSTANTIVE AUDIT TESTS FOR LEASE LIABILITES SUBSYSTEM Verify lease commitments and correct disclosure Ensure that capital leases are capitalised Auditor will carry out substantive testing on items such as: - reconciling balances in the general ledger - inspecting the lease contracts - ensure proper classification and capitalisation of finance leases - recalculation of lease liabilities 16

17. SUBSTANTIVE AUDIT TESTS FOR  ACCRUALS AND PREPAYMENTS The audit of accruals and prepayments is linked to accounts payables, accounts receivables and the cash payments subsystems. Substantive audit test will include:- - Prepare a list of all �balance date adjustments� and verify a sample to supporting documentation. - Recalculate the amounts reported in the financial statements 17

18. - Review the policies for the calculations - Reconcile opening balances to last years working paper, - Review records of payments/receipts after balance date to substantiate the adjustments for the accrual prepayment. 18

19. SUBSTANTIVE AUDIT TESTS FOR  TAX EFFECT SUBSYSTEM Reconcile accounting profit to taxable income Verify reconciling items and tax effect accounting procedures Ensure that tax effect accounting conforms with Accounting Standards and Taxation Law Confirm tax expense, tax payable and deferred tax asset and deferred tax liability amounts. 19

20. SUBSTANTIVE AUDIT TESTS FOR PROFIT & LOSS, BALANCE SHEET AND CASHFLOW STATEMENT Most of the verification of the amounts in these reports has occurred in the substantiative testing of each accounting subsystem. The auditor will: - Ensure that appropriate allocation of items - Ensure that statements apply to company policy - Perform an analytical review - Review statements for formal completion according to required accounting standards of disclosure. - Review notes to the accounts to ensure disclosure is in accordance to accounting standards 20

21. HOMEWORK FOR CHAPTER 15 Complete the following questions:- Self check questions page 303 Activity 15.1 to 15.3, 15.4 to 15.10 Read case study page 314 - 326 21