MGAD10H3 Chapter Notes - Chapter 10: Inventory Turnover, London Agreement On German External Debts, Bank Statement

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MGTD60H3 Chapter 10 Substantive Testing and Balance Sheet Accounts
Introduction:
- Objectives of substantive testing
- The factors that affect the nature, timing, and extent of procedures
- Process that impact significant accounts in the BS
- Illustrative procedures for auditing the significant accounts
10.1 Relationship between Risk Assessment and Substantive Procedures
- Substantive procedures are also called substantive testing or test of details
- Substantive procedures are audit procedures designed to detect material misstatement
at the assertion level
Extent of Substantive Procedures
- Extent of substantive procedures depends on the risk assessment for each significant
accounts
- Accounts that are clearly trivial and immaterial are ignored or only subjected to analytical
procedures
- Analytical Procedures are evaluations of financial information made by a study of
plausible relationships among both financial and non-financial data
o It encompasses the investigation of identified fluctuations and relationships that
are inconsistent with other relevant information or deviate significantly from
predicted amounts
- Professional judgement is critical and it is influenced by factors such as materiality, the
nature of the account balance or disclosure, and the risks identified
- Risk assessment is determined using the audit risk formula (inherent risk, control risk,
and detection risk)
- If inherent and control risks are assessed as low, substantive testing is needed
- If inherent and control risks are assessed as medium or moderation, a combination of
tests of controls and substantive procedures are required
Timing of Substantive Procedures
- Timing depends on the risk assessment of the significant account or disclosure in
question
o Significant account is an account or group of accounts that could contain material
misstatements based on their materiality and/or relationship to identified inherent
and FS risks
- The higher the detection risk for an account, the less work is needed to be performed,
and a greater reliance on the tests of control before year end is placed
- The lower the detection risk, the more work is needed to be performed, with the majority
of evidence being obtained by performing substantive procedures near or at year end
- Factors influencing timing of work performed:
o Reviewing events occurring prior to year end
Major business acquisitions or disposals
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MGTD60H3 Chapter 10 Substantive Testing and Balance Sheet Accounts
Key charges to expense accounts (payroll bonuses)
Major fixed asset additions or disposals
o Reviewing the activity in the period to date
Monthly review of the aging of TR
o Performing general audit procedures prior to year end
Accumulation of knowledge throughout the year
Review of board minutes, journal entries, and legal correspondence
Performed at interim date with an update at year end
o Reviewing provisions prior to year end
Familiarization with the approach taken by management prior to year end
so the auditor can begin to develop an expectation of the balances in
advance of the year end visit
10.2 Substantive Testing of Cash
- Presented as single line item on the BS
- Consists of cash on hand, cash in the bank, and cash equivalents
- Cash Equivalents are highly liquid investments that can be quickly converted into cash
- Imprest Payroll Accounts are accounts established for processing payroll disbursements
only
- Cash balance presented as a liability is called Bank Indebtness which happens when a
firm has access to a bank overdraft facility and has spent more cash on hand
- 3 (and 1 extra) important assertions regarding cash:
o Existence
Verified by the receipt of a confirmation from the bank
Bank should also confirm whether they are any additional accounts,
loans, pledges, lease facilities, or other banking facilities
o Completeness (balance completely reflects all cash transactions)
Testing bank reconciliation by vouching any differences between cash as
per the bank statement and cash as per the general ledger to supporting
documentary evidence
Fees and interests should be vouched to the general ledger as evidence
that client has reconciled the items
Difference between vouching a bank statement and a general ledger is
often the result of cheques that have been issued but have not yet
cleared the bank
o Classification
Additional information related to cash account that is required to be
disclosed in the FS
Unused credit facilities and other information that is part of the cash flow
statement disclosure requirements
o Rights and Obligations
Clients might have pledged assets such as cash (cash restriction)
o Valuation and Allocation is not as important but only in situations where clients
have foreign exchange transactions
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MGTD60H3 Chapter 10 Substantive Testing and Balance Sheet Accounts
Principal Objectives in Auditing Cash
- Note that classification assertion is different from classification and understandability
assertion
- Classification and understandability assertion relates to the presentation and disclosure
in the FS, while classification refers to transactions and events that occur throughout the
year (how they are recorded and if they are recorded in the right account)
1. All cash on the BS is held by the entity or by others (bank) for the entity (E)
2. All cash owned by the entity at year end is included in the BS (C)
3. Cash is stated at its realizable value (VA)
4. Entity owns or has legal rights to all the cash on the BS at year end (RO)
5. Cash is properly classified, described, and disclosed in the FS including all notes and
restrictions in accordance to IFRS/GAAP (CL and CU)
Factors Impacting the Audit of Cash
- Testing performed at an interim stage over cash receipts and disbursements
- If controls are effective, no additional test of control is required to be performed
- Thus, the auditor would perform substantive tests to audit cash at year end with no
additional process or control related testing required
- Most transactions flow through the cash account at some point and therefore cash is
qualitatively material
- Cash tends to have high inherent risk if an organization has a large number of cash
transaction during the year
- Cash is the easiest to steal
- Analytics over the cash accounts are generally not used because cash is considered
“lumpy” and unstable
- Procedures can be performed as part of control test (dual)
- Example of substantive tests of transactions cash:
CASH RECEIPTS PROCESS
CASH PAYMENTS PROCESS
Proof of cash by:
- Reconciling activity per client rectors to
activity per bank
- Correlate these transactions to the
activity in the sales and TR ledgers
- C, A
Account for the numerical sequence of
cheques issued during a specified period
- C, CO (Cut-off)
Compare remittance advices or lists of cash
receipts with entries in the cash receipts
journal
- CL, C
- Compare paid cheques and documents
with the cash disbursement journal
- Check if documents confirm it has been
paid
- C
- Compare the details of duplicate
deposit slips with entries in the cash
receipt journal
- Investigate abnormal delays in
Compare entries in cash journal with paid
cheques and supporting documents
- O (Occurrence)
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Document Summary

The factors that affect the nature, timing, and extent of procedures. Process that impact significant accounts in the bs. 10. 1 relationship between risk assessment and substantive procedures. Substantive procedures are also called substantive testing or test of details. Substantive procedures are audit procedures designed to detect material misstatement at the assertion level. Extent of substantive procedures depends on the risk assessment for each significant accounts. Accounts that are clearly trivial and immaterial are ignored or only subjected to analytical procedures. Analytical procedures are evaluations of financial information made by a study of plausible relationships among both financial and non-financial data. It encompasses the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts. Professional judgement is critical and it is influenced by factors such as materiality, the nature of the account balance or disclosure, and the risks identified.

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