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Audit Planning: How Auditors Construct Substantive Tests Program



In planning a financial statement audit, auditors should develop an overall program for (a) considering a client’s internal control—technically called “risk assessment”; and (b) performing substantive tests. In this post, I am focus on the second plan; constructing a program to perform substantive tests.

Substantive tests, in the financial audit world, are series of sequential procedures by which an auditor gathers competent evidences that support his/her opinion on fairness of clients’ financial statements—as it is required by the generally accepted fieldwork standard—after he/she got professional judgment about client’s internal control.


Performing substantive tests isn’t easy. It is daunting task that even senior auditors would definitely need a sound substantive tests program to accomplish the task. An auditor constructs the program during the audit planning session—and probably need some revisions (addition/omission) along the way. How do auditors construct substantive tests program?

Read on…


What Tasks Are Involved in Substantive Tests

Substantive tests, in general, involve the following five tasks:

1. Tests of transactions – In testing transactions, the auditor is concerned with tests of:

  • Omitted transactions and account understatement (tracing source documents to the books of entry)
  • Invalid or unsupported transactions and account overstatement (tracing recorded transactions to source documents)

2. Tests of details of account balances – In analyzing details of account balances, auditors use professional judgment in determining which accounts to scrutinize. Some of the accounts commonly requiring scrutiny are:

  • Repairs and maintenance
  • Fixed assets
  • Officers’ salaries
  • Contributions
  • Travel and entertainment
  • Income tax provisions

3. Analytical procedures – Analytical procedures include the study and comparison of the relationships between data. This involves the comparison of current period financial information with:

  • Prior period information
  • Expected results
  • Predictable pattern information
  • Intra-industry information
  • Non-financial information


How to Construct Substantive Test Program

To facilitate the audit, audit work programs should be developed for each account subject to examination. Audit work programs are easily developed by considering:

  • The auditor’s objectives
  • Generally accepted accounting principles
  • Required actions or procedures


What are the audit objectives?” you may ask.

Here are, in general, the objectives of a financial audit—which could provide a good framework for any audit program you may engage with:

  • Presentation and Disclosure – You (as an auditor) want to know whether the financial statements include all relevant footnote disclosures and are the statements appropriately classified OR not.
  • Valuation or Allocation – You want to assess whether the accounts accurately reflect appropriate amounts OR not.
  • Completeness – You want to make sure whether the accounts reflect all transactions executed in the accounting period OR not.
  • Existence or occurrence – You want to know if the recorded amounts of assets and liabilities actually exist, and further seeking answer if recorded transactions actually occurred in the accounting period.
  • Rights and obligations – You want to find out whether the entity maintain rights to its assets or not, and the entity’s liabilities its own obligations or not.
  • Related income statement effects – In this part, you want to know if there are income statement implications.


Can you give me an example of audit program?” you may further ask.

Below is a full series of example of substantive tests work program, for most common accounts you may engage with. Note that each substantives test—on each account—is consisted of the above audit’s objectives.


Substantive Tests of Cash Balances Example

A. Presentation and Disclosure

Step-1. Read or review the financial statements to verify proper classification.

Step-2. Read or review the financial statements to verify disclosures such as those relating to compensation balances.

Step-3. Determine the conformity with GAAP.

B. Valuation or Allocation

Step-1. Simultaneously count cash on hand and negotiable securities.

Step-2. Confirm directly with the bank:

  • Account balances
  • Direct liabilities to bank
  • Contingent liabilities to bank
  • Letters of credit
  • Security agreements under the Uniform Commercial Code
  • Authorized signatures

Step-3. Count petty cash fund and reconcile with vouchers.

C. Completeness

Step-1. Obtain bank cutoff statement and determine propriety of year-end outstanding checks and deposits-in-transit.

Step-2. Examine or prepare year-end bank reconciliation.

Step-3. Prepare a proof of cash.

Step-4. Perform analytical procedures.

D. Existence or Occurrence (See B above)

E. Rights and Obligations

Step-1. Read minutes of the board of directors’ meetings.

Step-2. Determine existence of compensating balances, levies, etc.

Step-3. Verify names on accounts through confirmation requests.

F. Related Income Statement Effects—not required


Substantive Tests of Receivable Balances Example

A. Presentation and Disclosure

Step-1. Determine appropriate classification of account balances.

Step-2. Read or review the financial statements in order to verify disclosure of

  • Restrictions—pledging, factoring and discounting
  • Related party transactions

Step-3. Trace amounts on trial balance to general ledger control accounts and subsidiary ledger totals.

B. Valuation or Allocation

Step-1. Confirm account balances where reasonable and practicable using positive and/or negative confirmation requests.

Step-2. Examine collections in the subsequent period cash receipts journal.

Step-3. Examine and verify amortization tables.

Step-4. Examine aging schedules.

Step-5. Review adequacy of allowance for doubtful accounts.

Step-6. Review collectibility by checking credit ratings (e.g., Dun and Bradstreet ratings).

Step-7. Verify clerical accuracy and pricing of salesinvoices.

Step-8. Foot daily sales summaries and trace to journals.

Step-9. Perform tests for omitted and invalid (or unsupported) transactions with respect to subsidiary ledger account balances.

C. Completeness

Step-1. Perform sales and sales return cutoff tests.

Step-2. Perform analytical procedures.

Step-3. Test for omitted transactions.

D. Existence or Occurrence

Step-1. Inspect note agreements.

Step-2. Confirm accounts receivable and notes receivable balances.

Step-3. Review client documentation.

E. Rights and Obligations

Step-1. Read minutes of board of directors’ meetings.

Step-2. Read leases for pledging agreements.

Step-3. Determine pledging and contingent liabilities to bank by using a standard bank confirmation.

F. Related Income Statement Effects

Step-1. Review installment sales profit recognition.

Step-2. Verify accuracy of sales discounts and term discounts.

Step-3. Review bad debt expense computations.

Step-4. Recalculate interest income on notes receivable.


Substantive Tests of Inventory Example

A. Presentation and Disclosure

Read or review the financial statements to verify footnote disclosure of:

  • Valuation method and inventory flow, e.g., lower-of-cost-or-market value, first-in-first-out
  • Pledged inventory
  • Inventory in or out on consignment
  • Existence of and terms of major purchase commitments

B. Valuation or Allocation

Step-1. Verify the correct application of lower-of-cost-or-market value.

Step-2. Recalculate inventory valuation under the full absorption costing method.

Step-3. Verify the quality of inventory items.

Step-4. Vouch and test inventory pricing.

Step-5. Perform analytical procedures.

Step-6. Verify the propriety of inventory flow.

Step-7. Consider using the services of a specialist to corroborate the valuation of inventory (e.g., a gemologist to corroborate the valuation of precious stones).

C. Completeness

Step-1. Perform cutoff tests for purchases, sales, purchase returns, and sales returns.

Step-2. With respect to tagged inventory, perform tests for omitted transactions and tests for invalid transactions.

Step-3. Verify the clerical and mathematical accuracy of inventory listings.

Step-4. Reconcile physical inventory amounts with perpetual records.

Step-5. Reconcile physical counts with general ledger control totals.

D. Existence or Occurrence

Step-1. Observe client inventory counts.

Step-2. Confirm inventory held in public warehouses.

Step-3. Confirm existence of inventory held by others on consignment.

E. Rights and Obligations

Step-1. Determine existence of collateral agreements.

Step-2. Read consignment agreements.

Step-3. Review major purchase commitment agreements.

Step-4. Examine invoices for evidence of ownership.

Step-5. Review minutes of the board of directors’ meetings.

F. Related Income Statement Effects

Verify that ending inventory on the balance sheet is identical to ending inventory in the Cost of Goods Sold section.


Substantive Tests for Fixed Assets Example

A. Presentation and Disclosure

Read the financial statements in order to verify:

  • Disclosure of historical cost
  • Disclosure of depreciation methods under GAAP
  • Financial statement classification
  • Disclosure of restrictions

B. Valuation or Allocation

Step-1. Examine invoices.

Step-2. Inspect lease agreements and ascertain the proper accounting treatment (e.g., capital vs. operating lease).

Step-3. Analyze repairs and maintenance accounts.

Step-4. Analyze related accumulated depreciation accounts.

Step-5. Vouch entries in fixed asset accounts.

Step-6. Test extensions and footings on client-submitted schedules.

C. Completeness

Step-1. Perform analytical procedures.

Step-2. Inspect fixed assets.

Step-3. Examine subsidiary schedules.

Step-4. Reconcile subsidiary schedules with general ledger control.

D. Existence or Occurrence

Step-1. Inspect fixed assets.

Step-2. Examine supporting documentation.

E. Rights and Obligations

Step-1. Inspect invoices.

Step-2. Inspect lease agreements.

Step-3. Inspect insurance policies.

Step-4. Inspect title documents.

Step-5. Inspect personal property tax returns.

Step-6. Read minutes of the board of directors’ meetings.

F. Related Income Statement Effects

Step-1. Recalculate depreciation expenses.

Step-2. Recalculate gain or loss on disposal of fixed assets.


What Else is Needed in Preparing a Substantive Tests Program?

The next steps, in developing an audit work program, are identifying the flow of transactions in the accounting process and developing an understanding of relevant generally accepted accounting principles.

Finally, you must select the appropriate audit procedures from among the following general procedures:

  • Inspection of related documents
  • Observation of procedures
  • Confirmation of account balances and existence of assets, liabilities and transactions
  • Inquiry of company personnel
  • Retracing of transactions from books to records
  • Recalculation of extensions and footings
  • Vouching of documents to verify propriety and validity
  • Counting of tangible assets
  • Scanning (quick-checking) of documents, schedules, and accounts
  • Scrutinizing of documents, schedules, and accounts
  • Reading or reviewing of documents, minutes of board meetings, and financial statements
  • Comparison of perpetual records with physical assets
  • Analysis of account balances

Although the nature of substantive tests is a matter of professional judgment, effective client internal control is a positive influence. For that reason, an auditor may decide to decrease the amount of substantive testing, omit certain procedures, and/or schedule interim testing. Weak internal control will, conversely, result in increased substantive testing, the need for additional audit procedures, and/or scheduling testing at or after year-end.

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