CPA P1 Auditing

TOPIC 18: TESTS OF CONTROL V SUBSTANTIVE TESTS

Audit Evidence

Auditors can get evidence as to the accuracy of the Accounts in two ways:

 A strong Internal Control system particularly in relation to the reliability of

the financial information produced

 Their own substantive tests

If internal controls are effective, the auditor can reduce the amount of checks
he does himself on the figures (substantive tests) because the clients own
Controls are providing assurance of the accuracy of the Accounts.

Tests Of Control -V- Substantive Tests

When auditors wish to rely on the internal controls of their clients, they

must first test them to ensure that they have operated correctly

throughout the period. These tests are known as tests of control. (Interim
Audit Stage)

When auditors test transactions and balances in the Accounts themselves, they
are said to be substantiating the figures – or carrying out substantive
tests.(Final Audit Stage). The difference between these tests can sometimes
be minimal.

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EXAMPLE

In order to control the accuracy of bank records, a company carries out a

bank reconciliation at each month end(The preparation of the Bank rec is a

control procedure). The auditor may test this control, to ensure that these
reconciliations are produced accurately, reviewed by a senior
employee/manager, and that errors are correctly dealt with.

If a client does not produce a bank reconciliation at its year end, the auditor

is likely to produce his own, as this helps to give assurance that the bank

balance on the Statement of Financial Position is accurate. In carrying out the

reconciliation himself, the auditor is performing a substantive test.

EXERCISE : Tests of Control V Substantive

For each of the following audit procedures, identify whether it is a control

test or a substantive test:

1. Auditor observes the company’s staff performing an inventory count

2. Auditor inspects a fixed asset to assess its value and condition

3. Auditor selects a sample of goods despatched notes (GDN’s) and

traces them through to the corresponding sales invoices, ensuring

they are recorded in the correct period

4. Auditor inspects a purchase invoice to look for a signature evidencing

that the details have been checked back to the purchase order and

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the goods received note (GRN)

5. Auditor compares this year’s Accruals figure with the previous year’s

figure

We have already seen that auditors have two basic approaches to form an
opinion that the Financial Statements being audited provide a true and fair view:

 Seeing a strong internal control system

 Verifying the balances and transactions themselves (substantive)

This results in auditors carrying out two types of test – tests of control, and
substantive testing (we saw this earlier in the Notes).

With a test of control, the auditor is interested in whether a control

procedure has operated correctly – the size of the transaction is irrelevant.

In other words, the auditor is checking that the company has been trying to

ensure that its Financial Statements are accurate by for example, company
staff reconciling the balance on the Payables Control A/c to the total of the
personal payables ledger on a weekly basis. Or for example, when auditing the
“bank and cash” figure, an auditor is told that his client performs bank
reconciliations at the end of every month. If the auditor looks for evidence that

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this reconciliation is indeed taking place every month, and is done properly, then
he is testing the control.

With a Substantive Test, the auditor is trying to gain assurance directly about
the accuracy of a figure in the Financial Statements.

For example, in a company where no bank reconciliations are performed, the

auditor may choose to perform one himself in order to gain assurance that

the bank figure in the Financial Statements is accurate.(Valuation/Accuracy

Assertion)

The key is to understand why the auditor is carrying out the test.

Interim & Final Audits

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The Interim Audit is helpful when auditors cannot get the necessary work

done between the year-end, and the deadline for the audit to finish. It is

often used to do the early stages of the audit – the detailed planning, and

the assessment and testing of internal controls.

Directors must always sign off the Financial Statements before the

Auditors sign their audit report.

Question:

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