Question

Substantive Testing and Cycle Testing

Briefly describe each separately

Answer 1

Substantive Testing:

This is also referred to as the vouching approach or the direct verification approach. In this approach, audit resources are targeted on testing large volumes of transactions and account balances without any particular focus on specified areas of the financial statements.

The Auditor reliance on substantive tests to achieve an audit objective related to a particular assertion may be derived from tests of details, from analytical procedures or from a combination of both. The decision about which procedure or procedures to use to achieve a particular audit objective is based on the auditor’s judgment on the expected effectiveness and efficiency of the available procedures. For significant risks of material misstatement, it is unlikely that audit evidence obtained from substantive analytical procedures alone will be sufficient.

Before using the results obtained from substantive analytical procedures, the auditor should either test the design and operating effectiveness of controls over financial information used in the substantive analytical procedures or perform other procedures to support the completeness and accuracy of the underlying information. The auditor obtains assurance from analytical procedures based upon the consistency of the recorded amounts with expectations developed from data derived from other sources. The reliability of the data used to develop the expectations should be appropriate for the desired level of assurance from the analytical procedure. The auditor should assess the reliability of the data by considering the source of the data and the conditions under which it was gathered, as well as other knowledge the auditor may have about the data. The following factors influence the auditor's consideration of the reliability of data for purposes of achieving audit objectives:

• Whether the data was obtained from independent sources outside the entity or from sources within the entity
• Whether sources within the entity were independent of those who are responsible for the amount being the audited
• Whether data was developed under a reliable system with adequate controls
• Whether the data was subjected to audit testing in the current or prior year

Investigation and Evaluation:

In planning the analytical procedures as a substantive test, the auditor should consider the amount of difference from the expectation that can be accepted without further investigation. This consideration is influenced primarily by materiality and should be consistent with the level of assurance desired from the procedures. Determination of this amount involves considering the possibility that a combination of misstatements in the specific account balances, or class of transactions, or other balances or classes could aggregate to an unacceptable amount.

Documentation of Substantive Analytical Procedures:

When an analytical procedure is used as the principal substantive test of a significant financial statement assertion, the auditor should document the following:

1. The expectation, where that expectation is not otherwise readily determinable from the documentation of the work performed, and factors considered in its development
2. Results of the comparison of the expectation to the recorded amounts or ratios developed from recorded amounts
3. Any additional auditing procedures performed in response to significant unexpected differences arising from the analytical procedure and the results of such additional procedures

Example of substantive procedures:

• Debtors balance confirmation
• Vendor confirmation on the outstanding balances/ No balance confirmation
• Bank statements

Cycle Testing:

An audit cycle is the accounting process that auditors employ in the review of a company’s financial information. The audit cycle includes the steps that an auditor will take to ensure that the company’s financial information is valid and accurate before releasing any financial statements. The audit cycle can call for different tasks to be performed at different times, for example inventory can be tested in August and account payable can be checked in November.

The Audit cycle typically involves several distinct steps and may include the identification process, where the company meets the auditors to identify the accounting areas that need to be reviewed. The audit methodology stage, where the auditors decide how the information will be collected for review, the audit fieldwork stage, where the auditors test and compare accounting samples and the management reviews the meeting stage, where the findings are presented by the auditors to the management team.

If the company records its inventory as an asset an it undergoes an annual audit, then the auditors will be conducting an audit of inventory. Given the size of massive of some of inventories, Auditor may engage in quite number of inventory audit procedures before they are comfortable that the valuation that the company stated for the inventory asset is reasonable.

If the company uses cycle counts instead of physical count, the auditors can still use the procedures related to physical count. They simply do so during one or more cycles counts and do so that at any time. There is no need to observe a cycle count that occurs at the end of the reporting period. Their tests may also evaluate the frequency of cycle counts, as well as the quality of the investigations conducted by the counters into variance found.