Question

In: Accounting

Ava is a first year staff accountant who is unsure of the difference between tests of...

Ava is a first year staff accountant who is unsure of the difference between tests of controls and substantive testing. For each of the following tests, indicate whether it is more likely to be used as a TEST OF CONTROLS or as a SUBSTANTIVE TEST by choosing the appropriate answer.

      -       A.       B.   

Compare current year actual sales to the current year forecasted sales.

      -       A.       B.   

Verify that voucher packages indicate agreement of purchase order, receiving report, and invoice.

      -       A.       B.   

Perform sales cutoff test.  

      -       A.       B.   

Inspect checks for restrictive endorsement prior to deposit.   

      -       A.       B.   

Observe the use of time clocks and time cards.  

      -       A.       B.   

Recalculate interest expense for reasonableness.

Solutions

Expert Solution

Before we answer this question, let us first try to understand a little about both the processes i.e. test of controls and substantive testing.

Test of Controls:

It involve the auditor testing processes or procedures carried out by staff at the client.

In every organisation, there will be business and accounting systems which should have appropriate controls in place.

There are a variety of different controls that can be broadly classified into five categories. The categories of control activities are; Authorisation, Performance Reviews, Information Processing, Physical, and Segregation of Duties (‘APIPS’).

Testing controls involve the auditor selecting some of the controls that the client carried out during the year, and checking to make sure that they operated effectively.

An example of a control could be where the client had a control whereby the monthly payroll summary had to be approved by the finance director before payment was made.

As a test of control, the auditor would look for evidence of that authorisation – most commonly the signature / initials of the Finance Director on a copy of the payroll summary.

Substantive Testing:

Substantive tests are the procedures that the auditor undertakes to detect possible misstatements that may exist in the financial statements, that is, testing the numbers at the year end.

When carrying out a substantive test, the auditor is testing to ensure that the figures included in the financial statements can be traced back to source documents and meet one or more of the audit assertions.

There are different assertions for items from the Profit or Loss Account, Balance Sheet, and disclosures.

Remember that the auditor won't test every number – he will select a sample based on risk, judgement etc.

Using the payroll example above – an example of a substantive test would be the auditor selecting a sample of employees paid in the year, and agreeing amounts paid to the payslips and bank statements.

Now, when we have a bit of idea about both the process, please see the answers as below.

(1) Compare current year actual sales to the current year forecasted sales = Substantive Test

(2) Verify that voucher packages indicate agreement of purchase order , receiving report and invoice = Test of Controls

(3) Perform Sales cut off test = Substantive Test

(4) Inspect checks for restrictive endorsement prior to deposit = Test of Controls

(5) Observe the use of time clocks and time cards = Test of Controls

(6) Recalculate interest expense for reasonableness = Substantive Test


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