Chapter 10

Substantive testing,
computer-assisted
audit techniques and
audit programmes

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 Learning objectives

• To describe the substantive procedures an auditor would perform to prove that

recorded transactions and figures are genuine, accurate and complete.
• To explain the purpose of selecting a sample when performing substantive
procedures.
• To draft suitable conclusions after substantive procedures have been
performed.
• To draft a management letter, containing recommendations on internal control
and other matters of interest to management and others charged with
governance, and to the auditor.

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 Substantive testing of transactions, balances,
disclosures
• Auditors use substantive procedures to test if transactions – processed and
controlled by accounting and control systems – are genuine, accurate and
complete. Reminder of definitions:
a) Substantive procedure – an audit procedure designed to detect material
misstatements at the assertion level. Substantive procedures comprise:
i. Tests of details (of classes of transactions, account balances, and disclosures); and
ii. Substantive analytical procedures.
b) Test of controls – an audit procedure designed to evaluate the operating
effectiveness of controls in preventing, or detecting and correcting, material
misstatements at the assertion level.

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Substantive ‘tests of detail’ and ‘substantive analytical procedures’

• Tests of detail: detailed testing of transactions and balances. Audit objective: to

ensure, e.g., turnover includes all despatches of goods.
• Substantive analytical procedures not concerned with detail. If analytical review
results are as expected, auditor might accept entity’s controls to ensure, e.g., sales
are genuine, accurate and complete.
• Auditors restrict substantive tests to analytical procedures if satisfied company
controls are strong. If deemed weak, solely analytical procedures not enough.
• Two reasons why substantive tests always performed:
1. Auditor’s assessment of risk judgemental: may not be sufficiently precise to identify all
risks of material misstatement .
2. Inherent limitations to internal control including management override.

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 Setting objectives before designing a programme of
substantive tests

• Substantive tests should be designed to prove the validity of

financial statement assertions of material account balances and
transaction classes (ISA 330).
• Means that auditors must be clear as to what they wish to achieve
before designing a programme of substantive tests.
• See Powerbase Case Study 10.1 (on the following slide). Read the
original audit programme for purchases and explain why it is
inadequate.

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 Powerbase case study 10.1 – original inadequate audit programme of
substantive tests for purchases
• Cheque payments. Select a sample of cheque payments for purchases of raw materials and check as
described below:
(a) Agree to invoices for goods received.
(b) Agree to goods received notes.
(c) Check calculations and additions on invoices.
• Purchase daybook.
(a) Select entries at random and examine invoices and credit notes for price, calculations and
authorization, etc.
(b) Check postings of entries to trade payables ledger.
• Purchase ledger.
(a) Select a sample of accounts and test check the entries into the books of prime entry, checking
the additions and balances carried forward.
(b) Enquire into all contra items.
• Conclusions.
Note any conclusions covering any weaknesses and errors discovered during the above tests for
possible inclusion in a management letter.
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Final purchases audit programme for Powerbase (1) Figure 10.1

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Final purchases audit programme for Powerbase (2) Figure 10.1
(continued)

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 The use of audit software
• Generalized audit software
• Software developed for use in specific industries
• Statistical analysis software
• Expert system software
1. Generalized audit software can only be used after the event
2. (a) Systems weaknesses can be discovered using audit software, but
difficult to assess likelihood of error.
(b) Not used continuously and conclusions not timely.
(c) Not very useful in detecting where system breakdowns are likely, e.g.
when system overload.

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Generalized audit software and software developed for
specific industries
• Interrogation tools primarily for substantive testing.
• Can confirm systems operating satisfactorily – e.g. confirm no blank fields in
customer data.
• Software designed for use in specific industries – similar to generalized
software but additional functions
• Generalized audit software can:
– access files with different characteristics and manipulate data, e.g. sorting and
merging files.
– select data on basis of predetermined criteria and perform arithmetical functions
on data selected.
– analyse selected data statistically and stratify into desired categories.
– create and update files from the company’s own files.
– produce reports for auditor in desired format.

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 Statistical analysis
• Software packages with regression analysis capabilities enable auditors to form
view on company trends.
• Generalized audit software to extract ratios and balances for comparison with
previous periods/external data.
• Generalized audit software can select data on statistically sound basis:
– select customers for circularization
– select inventory items for audit purposes.
• The software report writing facility might be used to:
– prepare summaries of customers selected
– list selected inventory items.
• Use of generalized audit software is supplement to statistical sampling
techniques

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 The use of computer-assisted audit techniques (CAATs)

• CAATs may enable more extensive testing of electronic transactions

and account files, which may be useful when the auditor decides to
modify the extent of testing, for example, in responding to the risks
of material misstatement due to fraud. Such techniques can be used
to select sample transactions from key electronic files, to sort
transactions with specific characteristics, or to test an entire
population instead of a sample. (ISA 330, para 16)

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 CAATs: examples (1)
Sales and trade receivables
1. Listing large sales transactions for special investigation.
2. As part of cut-off tests matching dates of SDNs and sales invoices; matching dates of
goods returned notes and credit notes.
3. Listing prices differing from official price lists and discounts exceeding a certain
percentage. Recalculating sales discounts.
4. Analysing sales per product line.
5. As part of completeness of recorded sales test, listing quantities despatched and
quantities invoiced.
6. Listing write-off of customer balances.
7. Listing credit note transactions, particularly those of high value or near the year-end.
8. Testing additions on invoices and trade receivable accounts.
9. Testing that sales have correctly entered the costing record.

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 CAATs: examples (2)
Inventories and production cost
1. Listing material changes in standard costs from previous year or period.
2. Comparing finished inventory records with sales data.
3. Identifying obsolete inventory by calculating inventory turnover statistics.
4. Identifying abnormal usage or costs.
5. Testing overhead cost allocations.
6. Comparing production usage with issues of raw materials and components from
inventory.
7. Comparing proportions of materials, components, labour and overheads in
production costs with those included in inventories.
8. Comparing inputs to production processes with outputs.

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 CAATs: examples (3)
Purchases and trade payables
1. Listing large purchases of goods and services for later examination.
2. Analysing purchases of goods and services for each month or year.
3. Comparing goods received data with recorded purchase invoices as part of the cut-off test.
4. Listing details of new suppliers.
5. Comparing outputs from financial accounting records of purchases to inputs to costing records.
Wages and salaries
1. Listing details of new or dismissed/resigning employees for later checking to supporting records.
2. Comparing date of first entry or last entry of employees on the payroll with date of
appointment/leaving in personnel records.
3. Testing mathematical accuracy of tax, social security and other deductions.
4. Testing payroll casts and cross-casts.
5. Testing outputs from financial accounting records of wages and salaries to inputs to costing records.
6. Comparing records on personnel and payroll files for consistency.

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 CAATs: examples (4)
Non-current tangible assets
1. Retrieval of non-current asset records to check that records for assets known to be in existence,
themselves exist.
2. Analysing assets by type, age and location.
3. Listing details of fully depreciated assets.
4. Testing reconciliation of assets recorded in non-current assets accounts to non-current assets register.
5. Reconciling non-current asset budget entries with subsequent purchases and printing material
variances.
Investments
1. Testing that income from all assets held is complete and accurate.
2. Listing changes in investment balance sheet values.
3. Comparing costs with investment market values.
Taxes on income
1. Identifying and analysing repairs above a certain amount to check validity of the capital/revenue
decision.
2. Listing subscriptions and donations to check for allowability as a charge against taxable income.
3. Listing motor vehicle usage by, and pension scheme contributions on behalf of, individuals for checking
to benefits in kind calculations.

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 Expert systems
• Expert systems useful when system or other area can be broken down into a
series of rules.
• Auditor answers questions on screen and program prepares report containing
action required, if critical.
• Checklists have been turned into a rules-based expert system, such as EDP/IT
checklists.
• Expert systems make expertise available to persons not experts themselves –
used for evidence collection and evaluation of risk, for instance:
– Is the company likely to face going-concern problems?
– Are any serious breaches in security likely?
– Appropriate audit programme steps after systems evaluation.
– Check legislation and accounting standards complied with.

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 Directional testing

• Substantive procedures should be designed to test for both over- or

understatement. One way to do this is to direct tests of detail of debit items to
detect overstatement and to test credit items to detect understatement.
• Apart from these tests of details, it would also be appropriate to perform
analytical procedures.

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Substantive audit programmes for wages and cash and
bank balances

• Suggested audit programmes are given in Appendix 10.1 and Appendix 10.2.

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Communication of audit matters to TCWG)(management letter)

• One objective of communicating to TCWG is:

To provide TCWG with timely observations arising from the audit that are
significant and relevant to their responsibility to oversee the financial
reporting process.
• The directors and others charged with governance have duty to ensure
internal controls are adequate – auditor informs them as soon as
possible of any weaknesses. This will help auditors in fulfilling their
duties if weaknesses are remedied. Weaknesses are likely to result in
increased audit time and TCWG should be informed of the reasons.

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 Management letter
• Management letter has a title and intended recipients clearly stated.
• The introduction explains why the letter came to be written.
• Responsible officials with whom the memorandum has been discussed.
• If auditor no reason to doubt integrity of officials, say so.
• A section stating the main conclusions.
• The main conclusions are then followed by detailed comments: brief description,
possible consequences and recommendations.
• Minor matters already cleared with management should not clutter the report.
• Auditors indicate willingness to discuss matters at greater length with TCWG and
asks for a response.

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Further matters of importance relating to the management letter

1. May be circumstances where not appropriate to discuss findings direct with

management, if integrity or competence is in question.
2. Where small entities have insufficient staff for full segregation of duties – letter
emphasizes importance of supervision by management.
3. Auditors report weaknesses that have resulted or may result in misstatements in
financial statements.
4. If no remedial action taken re significant weaknesses in controls raised
previously, current letter to refer to it. Auditor to ask why no remedial action
taken.
5. Auditors of public sector entities may have special responsibilities for reporting
internal control matters, e.g. compliance with regulations of legislative
authorities.

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 Audit management with the computer

Some ways in which audit automation is used:

• Risk assessment, planning and allocation of staff and other resources to the
audit assignment
• Information retrieval and analysis
• Interpretation and documentation of results
• Review and reporting activities
• Manuals and checklists on computer file
Two warnings:
1. Computer security applies equally to data held by the auditor on computer
file.
2. Spreadsheets can be an invaluable tool but their preparation needs careful
control.
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Figure 10.1 Powerbase plc purchases audit
programme

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Figure 10.2 Directional testing example (all figures in
thousands)

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Figure 10.3 Communication of audit matters to those charged with
governance (internal control section) at Broomfield plc

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Figure 10.3 (Continued)

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Figure 10.4 Audit programme for substantive tests of
production wages (Troston plc)

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Figure 10.5 Audit depth test: production wages
(Troston plc)

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