9.

Substantive
Procedures

Muhammed Jazeem ACCA, MCOM, PGDM

 Assertions
Assertions are used for transactions, balances and disclosures to see if sufficient
evidence on them has been collected. Assertions needs testing to see if they are
true or not. The reason to perform audit test to help the auditor to arrive at a
conclusion to whether the financial statements are free from material
misstatement.

A. Class of transaction and disclosure for the period

In general, this refers to income statement figures.
Occurrence: transactions and events that have been recorded have occurred and
pertain to the entity.

Accuracy: amounts and other data relating to recorded transactions and events
have been recorded appropriately.

Completeness: All transactions and events that should have been recorded, and all
related disclosures that should have been included have been included.

Cut-off: transactions and events have been recorded in the correct accounting
period.
Presentation and classification: Transactions and events are appropriately
aggregated or disaggregated and clearly described, and related disclosures are
relevant and understandable in the context of the applicable financial reporting
framework. Transactions and events have been recorded in the proper accounts.
Muhammed Jazeem ACCA, MCOM, PGDM
 B. Account Balances and disclosure at the period End
These will be the items on the statement of financial position.

Existence: assets, liabilities and equity interests exist.

Rights and Obligations: the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.

Completeness: all assets, liabilities and equity interests that should have been
recorded have been recorded.

Accuracy and valuation: all assets, liabilities and equity along with the disclosure
have been accurately recorded on the financial statement and valued as per the
accounting standards.

Presentation and classification: asset, liabilities and equity have been recorded in
the proper accounts and have been presented and described properly on the
financial statements based on the accounting standards.

Muhammed Jazeem ACCA, MCOM, PGDM

The assertions need testing to see if they're true

This is done by

Re-calculation
Analytical review
Re-performance
Enquiry
Confirmation
Observation
Physical verification
Inspection

Re- calculation
it involves verifying the mathematical accuracy of the client’s calculations. This
type of test is useful for confirming accuracy.

Analytical Procedures
This is the analysis of ratios and trends.
It includes investigating fluctuations between current and previous performance
and check whether other information is consistent with such relationship.

For example, comparing the rent charge from one period to the next and see
if other evidence such as number of rental properties corroborates the
increase or decrease.

Re-Performance
This can be recalculating figures or re-counting stock etc.

Enquiry
This means getting information from people inside or outside the entity.
It can be a formal written or an oral inquiry.

Confirmation
This means corroborating evidence from third parties with the internal evidence.
For example, confirming accounts receivables by circularising the debtors.

Muhammed Jazeem ACCA, MCOM, PGDM

Observation
This means watching others perform a procedure.
Examples include observation of
 Payment of wages
 Inventory counts/Stock count
 Opening mail
It gives assurance that official procedures are followed.

Physical verification
It means physical inspection of the asset. This gives conclusive evidence of
existence and may give evidence of valuation as the auditor will be able to see if an
asset looks in poor condition.

Inspection
This means the examination documents and records.
Things to inspect include: -
 Documentation
 Contracts
 Minutes

Muhammed Jazeem ACCA, MCOM, PGDM

 Audits of smaller entities

Smaller entities are under the direct control of the owners making it comparatively
easier to audit as the owners are aware of what are the activities of the Company
but there exists a high risk of manipulation of the figures or using company’s assets
for personal use.

Smaller entities are likely to have a simple system and bookkeeping errors
associated with smaller entities are likely to exist as manual system are rare these
days. But a system is operating effectively is dependable on the person operating
on it.

The characteristics of smaller commercial entities can lead to both advantages

and disadvantages:

• Lower risk – Smaller entities may be engaged in relatively simple activities which
reduces risk.

• Direct control by owner managers – Can be a strength because they know what is
going on and have the ability to exercise real control. However, they are also in a
strong position to manipulate the figures or put private transactions through the
business.

• Simpler systems – Smaller entities are less likely to have sophisticated IT

systems, but pure, manual systems are becoming increasingly rare. This is good
news in that many of the bookkeeping errors associated with smaller entities may
now be less prevalent. However, a system is only as good as the person operating
it.

Problems

• Management override – Smaller entities will have a key director or manager who
will have significant power and authority. This could mean that controls are lacking
in the first place or they are easy to override.
• No segregation of duties – Smaller entities tend to have a limited number of
accounts clerks who process information. To overcome this the directors should
authorise and review all work performed.
• Less formal approach – Smaller entities tend to have simple systems
and very few controls due to the trust and the lack of complexity. It is therefore,
difficult to test the reliability of systems and substantive testing tends to be used
more.

Muhammed Jazeem ACCA, MCOM, PGDM

Evidence implications

• The normal rules concerning the relationship between risk and the quality
and quantity of evidence apply irrespective of the size of the entity.
• The quantity of evidence may be less than for a larger organisation due to
fewer transactions being carried out.
• It may be more efficient to carry out 100% testing in a smaller organisation.

Muhammed Jazeem ACCA, MCOM, PGDM

 Audits of Not-For-Profit Organizations
Not-for-profit (NFP) organizations include charities and public sector entities.
Below are some important features of a NFP.

• Profit maximisation is not their main objective. Objectives will be either social or
philanthropic.
• There are no shareholders.
• They will not distribute dividends.

Financial statements
NFP organisations such as charities which are not established as charitable
companies will need to prepare:

• A statement of financial activities – showing income and expenditure

similar to a statement of profit or loss. As the organisation does not exist to
make a profit, any additional income over expenditure is known as a
surplus and any expenditure in excess of income is a deficit.

• A balance sheet – showing assets and liabilities, the same as a statement

of financial position.

• A cash flow statement.

• Notes to the financial statements.

Audit risks

Control risk
Some NFP entities, particularly small charities, may have weaker control systems
due to:

• being controlled by trustees who usually only work on a part time basis and are
volunteers. They may not devote sufficient time to adequately oversee the
strategic direction of the organization.

• a lack of segregation of duties, as the organisation may not employ many staff to
keep overheads down.

• the use of volunteers, who are likely to be unqualified and have little awareness of
the importance of controls.

• the use of less formalized systems and controls.

Muhammed Jazeem ACCA, MCOM, PGDM

Income
With many charities, much of the income received is by way of donation. Some
of these transactions will not be accompanied by invoices, orders or despatch
notes. For cash donations in particular there is a greater risk of theft. NFPs may
apply for grant income which will only be provided if certain criteria are met
otherwise the money may have to be repaid. There is a risk that grant income may
have to be repaid if the organisation does not use the money for its intended
purpose.

Restricted funds
Some donations are given with clauses stating the money must be used for a
particular reason. For example, money may be donated to a hospital for them to
purchase a specific piece of equipment or to be used by a specific department.
These restricted funds must be shown separately in the balance sheet and the
auditor must review donations to ensure that restricted funds are shown as such.

Going concern
Assessing the going concern status of a NFP entity may also be more difficult,
particularly for charities who are reliant on voluntary donations. Many issues,
such as the state of the economy, could impact on their ability to generate income
in the short term. Trends can also have an effect. For example, charities raising
money for medical research such as cancer and heart disease are seeing higher
numbers of donations whereas charities such as animal protection are seeing a
decline in income.

Complexity of regulations
NFPs may have complex internal and external regulations governing their activities,
reporting requirements and taxation system. This will mean the audit
team should have knowledge of these regulations and experience of auditing this
type of specialised entity in order to be able to perform the audit with sufficient
competence and due care.

Audit testing
Sufficient appropriate evidence will still need to be obtained through either a
mixture of tests of controls and substantive procedures or just substantive
procedures if the controls are ineffective or not in place. Procedures will still
involve enquiries, inspection, analytical procedures, etc.

Muhammed Jazeem ACCA, MCOM, PGDM

Reporting
If sufficient appropriate evidence is not obtained with respect to the above matters
as well as the usual risks of material misstatement faced by any organisation, the
auditor will have to modify the auditor's report.

Other reporting responsibilities

Quite often, the scope of the external audit of a NFP is much larger than that for
a company.

Auditors of NFPs may be required to perform additional assignments such as:

• Value for money audits – assessing whether the organisation is getting the most
out of the money spent. These are discussed in more detail in the chapter ‘Internal
audit’.

• Regularity audits – ensuring the expenditure of the organisation is in accordance

with the regulations/legislation governing it.

• Performance indicators – auditing the targets of the organisation that have to be

reported to stakeholders.

Muhammed Jazeem ACCA, MCOM, PGDM