Question

The following is an audit procedure that an auditor performs relating to the financial report audit of a client. Identify the broad category of audit test that is performed for the audit procedure. (Hint: The possible answers would include test of control, substantive test of ..., etc.) Examine creditor statement reconciliation for a sample of suppliers with whom the client had done business during the year

Answer 1

A test of controls is an audit procedure to test the effectiveness of a control used by a client entity to prevent or detect material misstatements. Depending on the results of this test, auditors may choose to rely upon a client's system of controls as part of their auditing activities. However, if the test reveals that controls are weak, the auditors will enhance their use of substantive testing, which usually increases the cost of an audit. The following are general classifications of tests of controls:

• Reperformance. Auditors may initiate a new transaction, to see which controls are used by the client and the effectiveness of those controls.

• Observation. Auditors may observe a business process in action, and in particular the control elements of the process.

• Inspection. Auditors may examine business documents for approval signatures, stamps, or review check marks, which indicate that controls have been performed.

Substantive testing is an audit procedure that examines the financial statements and supporting documentation to see if they contain errors. These tests are needed as evidence to support the assertion that the financial records of an entity are complete, valid, and accurate.

In order to examine the creditor statement reconciliation for a sample of suppliers with whom the client had done business during the year, the auditor shall follow below procedure -

Existence – means that liabilities really do exist and there has been no overstatement – for example, by the inclusion of fictitious inventory. This assertion is very closely related to the occurrence assertion for transactions.

Relevant tests – physical verification of non–current assets, circularisation of payables and the bank letter.

Rights and obligations – means that the entity has an obligation to repay a liability.

Relevant tests – Current assets are often agreed to purchase invoices although these are primarily used to confirm cost.

Completeness – that there are no omissions and assets and liabilities that should be recorded and disclosed have been. In other words there has been no understatement of assets or liabilities.

Relevant tests – Reconciliation of payables ledger balances to suppliers’ statements is primarily designed to confirm completeness although it also gives assurance about existence.

Accuracy, valuation and allocation – means that amounts at which liabilities recorded and disclosed are all appropriate.

Relevant tests – Vouching the purchase invoices.