[Zaiitz3]

Can someone explain these two in plain english? What are they, and when do you do substantive testing and when do you do analytical procedures? HELP!

*New York*
AUD 74, 88! 04/02/12
BEC 75! 08/30/12
FAR 68, 73, 83! 10/27/12
REG 80! 11/24/12

DONE!!!

"Be miserable. Or motivate yourself. Whatever has to be done, it's always your choice.” - Wayne Dyer

[CPA788]

I literally just took notes on this thread. Good times ya'll. Thank you!

BEC - 74, 77
FAR - 72, 71 (retake 7/29)
REG - 69
AUD - Q4 '16

CA Candidate

[fragchild]

The terminology confuses people, including myself at one time. Below items are all different things:

– Analytical procedures
– Substantive testing (aka substantive procedures), which is made up of the following:
1. Test of details
2. Substantive analytical procedures

You need to remember that analytical procedures is different to substantive analytical procedures!!

What is substantive testing? We use substantive testing to test transactions (i.e. expenditure from profit and loss statement) and balances (i.e. accounts receivable from balance sheet) in the financial statements are correct. To test these transactions (remember transactions are in the P&L statement) and balances (remember balances are in the balance sheet), we can either use test of details or substantive analytical procedures. Say for example we want to test payroll, we can do this by performing test of details which means selecting a sample of employees and checking if they were pay correctly by reviewing employment contracts, payslip, etc. Similarly we can use substantive analytical procedures to test the balance instead which generally means calculating an expectation. For example, say I know the average employee annual salary is $50,000 and the average employees during the year was 20. Therefore I create an expectation that the employee expenses is $1,000,000. Also, we normally have an acceptable threshold (generally based on mathematically formula). Say that we have an acceptable threshold of $50,000, if the actual employee expense in the companies accounting system is $1,020,000, then I can be sufficiently satisfied that employee expenses are correctly stated. However if the actual employee expense is $1,070,000, then I won't be satisfied and I will either need to find out why and update my substantive analytical procedure (might be skewed by 1 employee), or perform test of details if I'm not satisfied with the discrepancy.

Test of details generally provides most assurance that the numbers are correctly. Substantive analytical procedures is normally quicker to perform, and normally used on low risk transactions and balances.

Analytical procedures (note there is no substantive in front of it), is different and is performed in the planning (start) and reporting (end) stages. Why and what is it? It is performed to help us with our planning and assessment of risks. Analytical procedures is looking at the movements from prior year to current year (i.e. employee expenses increased by 10%), and sometimes ratios. We do this to determine whether we might need to perform more testing or how to perform our testing. For example, if we know that management agreed on an annual salary increase of only 3% and employee numbers have stayed the same, then this raises concerns to auditors as to why the employee expenses increased by 10%. Therefore we might change our strategy and use test of details instead of substantive analytical procedures.

[jslo123]

Dear fragchild,

you should start your own review course.

Fragchild CPA Exam Review

[Anonymous]

I want to bump this thread – which crazily enough began in 2011 and was just recently bumped again. I'm studying for AUD right now too and while I am not experiencing nearly the headaches with it that I did with FAR, there seem to be about a thousand pieces of little trivia that you have to know for AUD especially and they are sometimes very hard to remember.

Ok, so here goes my barrage of questions…

1. As I understand it, tests of controls are not even related to detection risk. Is that correct?
2. Test of controls are always done before even thinking about moving on to substantive procedures (learned this in Financial Auditing university course.)
So, we use tests of controls in order to arrive at the conclusion that either (A) client's internal control is good enough or (B) it isn't good enough.
If it isn't, then we need to move on with substantive procedures. If control risk is high, then allowable detection risk has to be lowered, and in order to do that,
we have to do more substantive testing. If control risk is low, we can pretty well skip substantive procedures/substantive testing.

Now, here's where I really get f'd up as far as terminology. And, I wasn't helped much by most of the previous explanations.

Tests of Details. What is this?? I can't find a dictionary definition for it anywhere except on this forum. It seems like it would fall under
Substantive Analytical Procedures. Are they the same thing? I don't think Tests of Details are Tests of Controls. For Test of Controls, we
do Reperformance-Inspection-Inquiry-Observation. And what are we testing? Authorization of transactions, Recording of transactions, Custody of assets, Commparisons (not sure what all we're comparing but fine.)

According to Roger's textbook, DR (Detection Risk) is comprised of TD Risk (Test of Details Risk) and Substantive Analytical Procedures Risk. I guess I just don't see
the fine line between the two.

I appreciate many of the previous explanations and how detailed they are but I really need a thumbnail (one or two short sentences) explanation of the difference between
substantive procedures and tests of details. And…. Analytical Procedures – are they *less substantive* than Substantive Analytical Procedures? If so, how?

Ighhhhh…. thanks.

[Yolonge]

Crazyleon – I do limited experience in audit process, but I will write what I know. I am typing this after midnight so it will not be very pretty.
Anyone correct me if I wrote something wrong. I will not be surprised if I screwed something up at this hour.

In audit, you would perform test of controls to test entity's control level, which may affect the control risk due to lack of proper internal control which can lead entity not discovering potential misstatement due to fraud or error. Unless your client is very small, you can never fully perform substantive testing because it is simply impossible. Therefore you will have to put some reliance unless control is completely broke or nonexistent.

The reason why test of control is tested (aside from it being required procedure) is because if you have more reliance on client's control, you can reduce amount of substantive testing/test of detail and perform more analytical procedure which then saves time and budget. Remember, audit is all about obtaining reasonable assurance and we never claim absolute assurance and properly assessed internal control can increase audit efficiency while not affecting audit effectiveness.

For example, say you are looking at cash disbursement process for one client. Based on your understanding of the entity and walk-though & understanding of client's internal control and control environment, you have concluded that control is effect with multiple level of supervision and it would be very difficult for someone or people to perpetrate the control and commit fraud. Given the confidence obtained, audit team may conclude that given the control in place, we can reduce level of substantive testing/test of detail on cash disbursement. Audit team may even omit substantive testing and go with test of controls if they conclude if that is sufficient. Test of controls would be something like proper approval from someone for disbursement instead of testing detail (invoice, bank statement, disbursement register, etc.).

Not properly assessed internal control can impact detection risk which is auditors' procedure failed to detect material misstatement. Say audit team skipped substantive testing on cash disbursement, but their initial assessment was wrong and therefore test of control itself did not provide sufficient evidence that cash disbursement is correctly recorded and therefore it failed to detect material misstatement, which affected level of detection risk and ultimately audit risk.

Analytical procedure can be used as part of substantive testing, but not the other way around. Given how things are related in while audit risk formulate, sometimes it can be in the gray area. Also the best phase “it depends” factor in as well.

In conclusion, test of control is usually performed during planning/preliminary phase, generally before substantive testing because auditors' assessment of internal control will affect nature, timing, and extent of audit procedures. Understanding obtained from test of controls helps auditors to plan the audit accordingly, and generally used to build efficient yet effective audit with available time (budget). Wrong assessment of internal control can affect auditors' detection risk because audit engagement can be based on assessed level of client's internal control, but if auditors' assessment was wrong from the beginning, while assumption was wrong to begin with and audit effectiveness is affected (it can be efficient because test of detail was omitted, but it was not an effective audit because material misstatement was not detected).

The whole point of audit is obtain reasonable assurance of financial misstatement due to fraud or error, in most efficient way. Everyone can have effective audit if they spend countless hours, but if your budget is that big, you will never win client in proposal because your fee will be too high..

Materials: Wiley book + Ninja MCQ

FAR - 83 (Jan 2016)
Study time: 6 weeks
BEC - 87 (April 2016)
Study time: 2 weeks
AUD - 92 (July 2016), (74 Feb 2016), (72 May 2016)
Study time: 4 (Feb) + 2 (May) + 3 (July) = 9 weeks total
REG - (70 April 2016)
Study time: 3 weeks

[Anonymous]

@mhei8116 thank you for your detailed reply. I appreciate your taking the time to respond. It seems like there are a small number of definitions/terms that are not well defined on this CPA exam journey.

Now, for substantive procedures, does that usually involve sampling transactions? It would seem so; control tests are not as detailed and I doubt sampling is ever done in control testing. Ok, let's say you wanted to do a more detailed test of cash disbursements. Let's say the client undergoing your audit did lots of cash-related stuff every single day. Lots of cash going in and out. You want to find out how well they record it all and that the cash on the balance sheet as of year-end matched the amount recorded. For your analytical procedure here, would you do statistical sampling and check those transactions? You know that the company's internal control for cash is good and therefore, you probably don't absolutely have to do it but in light of the fact that they're so cash-heavy, it wouldn't make sense to ignore substantive testing for this particular item.

One of the above posts mentioned that substantive procedures/analytical procedures utilize ratios. Ok, good. But I think, depending on what item you're auditing (Cash, AR, AP, whatever), ratios are only going to give you so much info. Or, is the ratio analysis done with numbers obtained in substantive procedures?

Now, having said that, is the ultimate objective of control testing to ascertain whether or not the risk of material misstatements is high? Or are there other reasons?

As you can tell no doubt, I have never done auditing.

[Author]

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