Question

Question 7: Substantive Tests
You have been engaged to audit the financial statements of Brew Ltd for the financial year ended 30 September 2017. The company is well established and has been selling craft beer to around 50 popular local restaurants and bars for the past 10 years. The company has good internal controls and keeps detailed records of sales, which allow for weekly analysis by customer. Sales are seasonal (demand is higher in summer), but highly predictable due to the trends identified over the past 10 years and the relatively loyal and stable customer base. John Castle, the managing director and major shareholder is fairly relaxed about reporting deadlines as long as Companies Act requirements are met.
John Castle has confided to you that he is a little concerned about their data capture processes for the two weeks 25th September to 8th October. They were sending out substantial quantities of craft beer to customers over this period as demand increased due to traditional local Spring festival celebrations. Unfortunately, their accountant Jayed was very ill around this time with flu. A large pile of sales invoices and delivery notes accumulated over the two weeks. Jayed has employed a temporary assistant to help catch up with capturing these sales onto their accounting information system from, but she has been complaining that the assistant keeps using the current date rather than the date of sale when entering the sales.
You are currently planning the audit of the Accounts receivable and Sales balances.
Required:
a) Briefly explain how the information provided in the first paragraph of the scenario above would affect the nature, timing and extent of substantive procedures for sales;
b) Briefly explain:
i. Which assertion is at risk due to Jayed’s illness and subsequent arrangements to catch up on capturing sales; (1 mark)
ii. The potential misstatement this is likely to cause for sales and debtors; (1 mark)
iii. What audit procedures, including the use of CAATs, you would carry out to address this risk

Answer 1

a..Substantive tests /procedures are carried out by the auditor to substantiate /validate the balances found in the client's financial statements against variuos items --so as to help him in asserting that there are no material misstatements with respect to completeness, validity & accuracy of the financial records , being audited.

So, it naturally follows that the company's internal control system is effective, the auditor may have to resort to more of tests of controls(ie. Test-checking the effectiveness of internal controls maintained) and less of the above substantive tests.

Conversely,if the internal controls seem to be deficient,then the auditor will have to employ his time on more substantive tests.

Normally substantive procedures include the following activities:

Verification of transactions, balances disclosed under various account heads & their conformity to the financial statements & Notes attached therewith.

The above includes mainly verification of adjustment entries so as to ensure prope/just & adequate provisioning .

The above requires enquiry, observation & analysis of various documents along with personal interactive sessions, with concerned officers , to form an opinion.

Here,

As the company has good internal controls and keeps detailed records of sales, which allow for weekly analysis by customer & sales revenues are highly predictable due to the trends identified over the past 10 years added with the advantage of loyal and stable customers, the auditor can test check the existing controls for the rest of the period , but for those two weeks.

For the 2 weeks in question he has to adopt detailed substantive tests , for purposes of assertion --in the areas of receivables & sales of the period:

Compare customer orders with billed invoices -also linking to collections.

Confirmation from bank regarding collection

Confirmation of balances from third-party,ie. Customers

Discuss with management about any problematic receivable account

Checking the physical inventory , to match purchases & goods sold & their calculations

So, it has to be a detailed substantive test for those 2 weeks & test of controls for the rest of the period.

b… Given that:

"A large pile of sales invoices and delivery notes accumulated over the two weeks"

"she has been complaining that the assistant keeps using the current date rather than the date of sale when entering the sales"

I.Going by the above, accuracy, completeness & cut-off assertions are at risk of being mis-stated.

II. Potential mis-statement

As to accuracy--- due to the volume of work by a new hand, accuracy in recording the correct amounts of sales & hence receivables.

as to Completeness---possible error due to leaving out/missing out on invoices

As to cut-off---error in entering sales in different dates than that occurred -which might lead to wrong calculations within the reporting period.

III. Audit procedures

Procedures undertaken including the Computer Assisted Auditing Technique must aim the following, with respect the 2 weeks , that lack controls:

Arriving at fool-proof balances (with the help of CAAT) for the period ending just before the 2 problem-weeks & starting from there-on--so that there will be adequate focus on the work of this period.

Serialising the invoices , so that nothing is missed in between

Tracing the entire route--sales invoice-Recievables--collections-- balance in receivables(including credit terms)

Discussion with the concerned officers for corroboration,identifying/fixing trends & confirmation.