Substantive procedures - F8

Substantive procedures are audit procedures that are done to test whether financial statement assertions are being met. As stated in earlier post, the assertions include ACCA COVER (accuracy, completeness, cut-off, allocation, classification, occurrence, valuation, existence, rights and obligations) where you can ignore allocation. Therefore, in running these procedures, first thing to do is to think of what assertion are you testing for. In exam, if you are asked to describe your procedure,don't only list the procedure but also explain what you are testing for. I will give a number of examples below.

Inventory

For the case of inventory, you may need to test for completeness, cut-off (amount is recorded in correct period), classification (in the case of consignment inventory, not likely to appear in exam), valuation (accuracy is for income and expenses while valuation is more assets, liabilities and equity), existence (whether the physical inventory exists, occurrence is used for income and expenses) and rights (whether the company has the ownership right).
If you are testing whether the inventory is valued correctly, your substantive procedure can be described like this: "review the condition of items of inventory to ensure that the valuation of those items is correct on the final inventory summaries." Common sense tells us that if the condition of the inventory is not good, there might be impairment and therefore the risk of overstatement of inventory. You also need the knowledge of IAS 2.
If you are testing existence: "for a sample of items recorded, physically inspect the items to ensure that they exist." If you did not write "to ensure that they exist" then you will only get 0.5 mark, be careful.

Receivables

The assertion includes cut-off, existence, classification, valuation, completeness and rights.
If you are testing existence, one good way is to use receivable circularisation which is a form of confirmation where auditors request for direct confirmation with the receivables.
If you are testing completeness, analytical procedure is useful: "calculate average receivable days and compare this to prior year, investigate any significant differences".
For cut-off, example can be "select a sample of goods despatch notes (GDNs) before and just after the year end and follow through to the sales invoice to ensure they are recorded in the correct accounting period".
For classification: "review the sales ledger for any credit balances and discuss with management whether these should be reclassified as payables".

Liabilities

Assertion includes valuation, existence, classification, cut-off, completeness and obligation. You will need knowledge of IAS 37 to deal with provisions and contingencies.

Equity (share capital, retained earnings and revaluation reserve)

This is not likely to be asked in exam so just get some ideas. You will refer to share register to ensure that issued share capital is correctly stated. Prior perid working papers give evidence on retained earnings. Revaluation surplus or decifit should be compared to valuer's report.

Non-current assets

Assertion includes completeness, existence, valuation, rights and classification.
If you are testing right, you might be looking for title deeds for ownership or purchase invoice to show evidence of acquiring the right.
If you are testing valuation, reasonableness of depreciation is one factor to consider. We might need to "obtain management representation to confirm the reasonableness of the management's estimate of depreciation rate". This is because depreciation rate is an accounting estimate and we can't obtain much evidence other than requesting from management. Whenever the knowledge of facts is confined to management or the matter is principally one of judgement/opinion, we will need to obtain evidence from management representation (ISA 580).

Bank

Assertion includes completeness, existence, cut-off, valuation and right. Bank confirmation is useful to obtain evidence on many of the assertions.
If you are testing completeness:" agree all balances listed on the bank confirmation letter to company's bank reconciliations or trial balance (completeness)". You can use "agree to" for testing completeness in any financial statement elements.

Income (normally sales)

Assertion includes occurrence, completeness, accuracy and cut-off.
To test for occurrence: "for a sample of entries in receivables ledger, agree back to sales invoices to ensure that the transaction has actually occurred".
To test for accuracy" "for a sample of sales invoices, agree the amount to corresponding entries in sales day book/sales ledger to ensure that the amount is accurately recorded".

Expenses (normally purchase and payroll)

Assertion is similar to the assertion of income.
If you are testing cut-off for purchase: "for a sample of GRNs in the week pre and post-year end, trace to the supporting invoice and entry in the payables ledger, ensuring that it is recorded in correct accounting year".

You don't need to remember anything of the above other than ACCA COVER. The procedures are all audit common sense. Also, don't remember what assertions are for what elements, understand why, for example, we test for valuation in assets and accuracy in income. Your approach to substantive procedure should be first to think of financial statement assertions, then come up with a procedure to test it. I give some examples above just to show you how to answer in exam, exam will be more demanding than the above. You should not remember the audit procedures listed in textbook, you should look at the scenario given and come up with your own sensible audit procedures.