ACFI3005 Topic 9 Homework Solutions Substantive Test Balance Sheet PDF

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ACFI3005 Audit and Assurance - Homework Solutions Topic 9 - Chapter 10 – Substantive testing and balance sheet accounts 10.12 What does interim testing mean? Give some examples of substantive tests that can be done before the end of the year? Interim testing means conducting audit procedures during the year, instead of waiting until after the year ends. It is more likely for accounts with low overall risk assessments, and yearend testing is more likely for accounts with high overall risk assessments. A low overall risk assessment means that planned detection risk is high, which in turn means that less work needs to be performed. Most evidence from this work is likely to be obtained from controls testing during the year, with a small amount of substantive testing. A high overall risk assessment means that detection risk is low, which in turn means that more work needs to be performed. This work is less likely to be obtained from controls testing during the year and more likely to be obtained from a variety of substantive tests performed near or at the reporting date. An auditor has some opportunities to perform some substantive procedures prior to year-end. Some events or transactions occur prior to year-end and then stay in the balance, for example, major acquisitions or disposals. These could be audited prior to year-end. Events or transactions that occur throughout the year could be reviewed prior to year-end and then updated at year-end. Some general audit procedures could be performed during the year, such as reviewing board minutes and some statutory records. These are updated at year-end. Provisions can be reviewed prior to year-end, then updated and checked to see if the final balances agree with the auditor’s expectations formed at the interim date. The external auditor could use results from the internal audit function to increase their understanding of internal controls.

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10.14

How does the result of controls testing affect auditing of the processes impacting cash and the substantive testing of the cash balance?

The processes impacting the cash balance are the cash receipts and cash payments processes. If the auditor has performed controls testing for these processes and concluded that the controls are effective and can be relied upon, it is unlikely that any additional tests related to the processes would be performed. The auditor would rely on substantive testing of the cash balance at year-end. However, if substantive testing of the significant transactions is required (because control testing did not provide sufficient evidence or it is considered more efficient to test the transactions), examples of the procedures are listed in Table 10.2. Substantive testing of cash balance at year-end is focussed on existence, completeness and classification of the cash balance. Existence is normally tested through a bank confirmation. Completeness tests focus on testing the client’s bank reconciliation and cut-off of cash transactions. Further examples of substantive tests for year-end cash balances are provided in Table 10.3.

10.17 Explain how subsequent receipts tests provide useful evidence about debtors’ valuations. Subsequent receipts testing is vouching the trade receivables at year-end to the subsequent receipt of cash from the customer. This test provides evidence about valuation of debtors’ account at year-end because the customer has subsequently paid the account. If it is paid after year-end, it is valued appropriately at year-end. If an account is not paid, there is some doubt about its valuation at year-end. The customer might pay at a later date, or there could be a dispute which may result to bad debt.

10.21 Explain why completeness is a more critical assertion for liabilities than for assets. What procedures are primarily designed to address the completeness assertion for payables? The completeness assertion relates to the objective of ensuring that the balance sheet accounts are not understated. Although this is important for assets, it is generally more important for liabilities because the consequences are likely to be more serious. If assets have to be revised upwards at a later date, shareholders' equity becomes greater. If liabilities have to be revised upwards at a later date, shareholders equity becomes smaller, potentially negative, which could result in the client’s liquidation. Typical procedures used to address the completeness assertion for payables include:  Testing the occurrence of cash payments (to ensure that a payable is correctly recorded as paid)  Testing the completeness of purchasing (to ensure that a payable is not incorrectly omitted from the balance sheet)

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Testing the accuracy and cut-off of purchases and cash payments (to ensure that they purchases and payments has been correctly included or excluded from payables based on the invoice date or cash payment date). Testing of subsequent payments (to detect payments of payables which were not recorded at year-end) Reviewing payables ledger and cash payments ledger for unusual items Search for unrecorded liabilities at stocktake date and/around year end Analytical procedure such as comparing a list of payables with those of prior periods and investigating any unexpected and significant changes (or absence of changes), such as significant increase of suppliers, ageing, pattern of purchases Compare payables in sub-ledger with general ledger account Review board minutes for discussion of major suppliers.

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