Annual Audit Manual

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7011 Determine the level of evidence required from substantive procedures
Sep-2022

In This Section

Definition

Requirement to perform substantive procedures

Meaning of material class of transactions, account balance and disclosure

Nature of substantive testing—High level of evidence obtained from controls testing

Nature of substantive testing—Partial or no evidence from controls testing

Definition

CAS Guidance

For purposes of the CASs, the following term has the meaning attributed below (CAS 330.4(a)):

(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

Requirement to perform substantive procedures

CAS Requirement

The auditor shall design and perform further audit procedures whose nature, timing and extent are based on and are responsive to the assessed risks of material misstatement at the assertion level (CAS 330.6).

In designing the further audit procedures to be performed, the auditor shall (CAS 330.7):

(a) Consider the reasons for the assessment given to the risk of material misstatement at the assertion level for each significant class of transactions, account balance, and disclosure, including:

(i) The likelihood and magnitude of misstatement due to the particular characteristics of the significant class of transactions, account balance, or disclosure (that is, the inherent risk); and

(ii) Whether the risk assessment takes account of controls that address the risk of material misstatement (that is, the control risk), thereby requiring the auditor to obtain audit evidence to determine whether the controls are operating effectively (that is, the auditor plans to test the operating effectiveness of controls in determining the nature, timing and extent of substantive procedures); and

(b) Obtain more persuasive audit evidence the higher the auditor’s assessment of risk.

Irrespective of the assessed risks of material misstatement, the auditor shall design and perform substantive procedures for each material class of transactions, account balance, and disclosure (CAS 330.18).

CAS Guidance

Paragraph 18 requires the auditor to design and perform substantive procedures for each material class of transactions, account balance, and disclosure. For significant classes of transactions, account balances and disclosures, substantive procedures may have already been performed because paragraph 6 requires the auditor to design and perform further audit procedures that are responsive to the assessed risks of material misstatement at the assertion level. Accordingly, substantive procedures are required to be designed and performed in accordance with paragraph 18 (CAS 330.A43):

  • When the further audit procedures for significant classes of transactions, account balances or disclosures, designed and performed in accordance with paragraph 6, did not include substantive procedures; or

  • For each class of transactions, account balance or disclosure that is not a significant class of transactions, account balance or disclosure, but that has been identified as material in accordance with CAS 315.

This requirement reflects the facts that: (a) the auditor’s assessment of risk is judgmental and so may not identify all risks of material misstatement; and (b) there are inherent limitations to controls, including management override.

Not all assertions within a material class of transactions, account balance or disclosure are required to be tested. Rather, in designing the substantive procedures to be performed, the auditor’s consideration of the assertion(s) in which, if a misstatement were to occur, there is a reasonable possibility of the misstatement being material, may assist in identifying the appropriate nature, timing and extent of the procedures to be performed (CAS 330.A44).

The auditor’s assessment of the identified risks of material misstatement at the assertion level provides a basis for considering the appropriate audit approach for designing and performing further audit procedures. For example, the auditor may determine that (CAS 330.A4):

(a)     Only by performing tests of controls may the auditor achieve an effective response to the assessed risk of material misstatement for a particular assertion;

(b)     Performing only substantive procedures is appropriate for particular assertions and, therefore, the auditor excludes the effect of controls from the assessment of the risk of material misstatement. This may be because the auditor has not identified a risk for which substantive procedures alone cannot provide sufficient appropriate audit evidence and therefore is not required to test the operating effectiveness of controls. Therefore, the auditor may not plan to test the operating effectiveness of controls in determining the nature, timing and extent of substantive procedures; or

(c)     A combined approach using both tests of controls and substantive procedures is an effective approach.

The auditor need not design and perform further audit procedures where the assessment of the risk of material misstatement is below the acceptably low level. However, as required by paragraph 18, irrespective of the approach selected and the assessed risk of material misstatement, the auditor designs and performs substantive procedures for each material class of transactions, account balance, and disclosure.

CAS 315 requires that the auditor’s assessment of the risks of material misstatement at the assertion level is performed by assessing inherent risk and control risk. The auditor assesses inherent risk by assessing the likelihood and magnitude of a misstatement taking into account how, and the degree to which the inherent risk factors affect the susceptibility to misstatement of relevant assertions. The auditor’s assessed risks, including the reasons for those assessed risks, may affect both the types of audit procedures to be performed and their combination. For example, when an assessed risk is high, the auditor may confirm the completeness of the terms of a contract with the counterparty, in addition to inspecting the document. Further, certain audit procedures may be more appropriate for some assertions than others. For example, in relation to revenue, tests of controls may be most responsive to the assessed risk of material misstatement of the completeness assertion, whereas substantive procedures may be most responsive to the assessed risk of material misstatement of the occurrence assertion (CAS 330.A9). 

The reasons for the assessment given to a risk are relevant in determining the nature of audit procedures. For example, if an assessed risk is lower because of the particular characteristics of a class of transactions without consideration of the related controls, then the auditor may determine that substantive analytical procedures alone provide sufficient appropriate audit evidence. On the other hand, if the assessed risk is lower because the auditor plans to test the operating effectiveness of controls, and the auditor intends to base the substantive procedures on that low assessment, then the auditor performs tests of those controls, as required by paragraph 8(a). This may be the case, for example, for a class of transactions of reasonably uniform, non‑complex characteristics that are routinely processed and controlled by the entity’s information system (CAS 330.A10).

OAG Guidance

Refer to OAG Audit 5042 for guidance on identifying significant FSLIs and relevant assertions. This manual section provides guidance on substantive procedures that would be performed over the FSLIs that are determined to be not significant, but that are material.

In selecting particular substantive tests to obtain sufficient appropriate audit evidence, we consider, among other things, the risk of material misstatement of the financial statements, including the assessed levels of control risk, and the expected effectiveness and efficiency of such tests. These considerations include the nature and materiality of the items being tested and the quantity and quality of available evidence.

The nature, timing, and extent of the procedures to be applied on a particular engagement are a matter of professional judgment, based on the specific circumstances.

The evidence necessary to either corroborate or contradict the assertions in the financial statements, and thus provide us with a reasonable basis for an opinion, is obtained by designing and performing tests of controls and substantive tests.

Meaning of material class of transactions, account balance and disclosure

OAG Guidance

There is no formal CAS definition of account balances, classes of transactions, or disclosures. However, we generally interpret this phrase as including amounts that are separately disclosed in the financial statements (account balances presented on the balance sheet, classes of transactions presented on the income statement, and disclosures in the notes) and refer to classes of transactions, account balances and disclosures as ‘FSLIs’ (see OAG Audit 5041).

For further guidance on identifying significant FSLIs, including the level at which to identify significant FSLIs, refer to OAG Audit 5042.

We need to design and perform one or more substantive procedures for each relevant assertion for all significant FSLIs. This will be the case irrespective of the sufficiency and adequacy of the audit evidence obtained from tests of controls.

For an FSLI that we do not determine to be significant but that is material (i.e., an FSLI for which we identified no relevant assertions, but the FSLI exceeds materiality), we identify the assertions for which we will perform substantive procedures by identifying one or more assertions for which a misstatement, if it were to occur, could be material. For guidance on FSLIs not determined to be significant but that are material, including selecting assertions to test, refer to OAG Audit 5042.

When considering the nature and extent of substantive procedures to be performed, remember that:

  • Substantive Procedure steps are leverageable; therefore, substantive tests performed in related areas may be sufficient to provide the necessary substantive evidence for specific assertions related to more than one FSLI. For example, work performed on year-end accounts receivable balances may provide sufficient evidence on revenue cut‑off.

  • Substantive tests of details and analytical procedures will generally provide evidence for more than one assertion / risk—this will often be the case with substantive analytical procedures.

  • Tests of controls comprising reperformance or examination of evidence may be dual‑purpose, i.e., tests of transactions that both evaluate the effectiveness of controls and serve as substantive tests. For example, reperforming a reconciliation where evidence supporting the reconciling items is examined will provide substantive audit evidence when planned and performed in an appropriate manner.

Relating the evidence obtained from auditing procedures to the financial statement assertions is an iterative process of accumulating, analyzing, and interpreting information in light of our expectations, previous audit knowledge and experience, generally accepted accounting principles, and good management practices. Procedures performed to test one relevant assertion for one significant FSLI frequently generate information that requires further action by us to achieve evidence related to other assertions for that particular FSLI or other FSLIs. Evidence that raises questions, for example, about recorded revenues also may raise questions about the adequacy of the allowance for doubtful accounts and inventory obsolescence, which in turn will require us to accumulate and analyze additional evidence.

Nature of substantive testing—High level of evidence obtained from controls testing

OAG Guidance

Where we obtain high controls reliance through testing the operating effectiveness of controls (where considered effective and efficient in the engagement circumstances), we may be able to obtain most of the additional evidence we need from substantive analytical procedures and/or targeted tests of details focused on items with higher risk or higher monetary value. For example:

  • High controls reliance exists and substantive analytics are performed with sufficient rigor, using a maximum threshold of performance materiality, therefore the need for additional testing may be limited to specific assertions (e.g., cut‑off) that may relate to significant risks or elevated risks.

  • In certain circumstances, targeted testing of significant contracts may provide the required level of evidence (e.g., when most of the revenue balance relates to several significant contracts and the risk in the remaining revenue population is considered as acceptably low).

Although we may have already carried out analytical procedures as part of our risk assessment procedures, they will probably have been applied to earlier figures and without the rigor needed to derive audit evidence. For analytical procedures to constitute a substantive test, they need to be performed with sufficient precision and rigor. See OAG Audit 7033 for further details on substantive analytics.

In order to determine what additional substantive audit evidence is needed for each relevant assertion, analyze the audit plan developed based on our assessment of the risk of material misstatement and for each material class of transactions or account balance:

  • Identify the assertions for which we plan to obtain evidence from testing the operating effectiveness of controls.

  • Assess the level of evidence that is expected to be obtained.

  • Identify substantive procedures that need to be performed and determine the nature, timing, and extent of those procedures.

Nature of substantive testing—Partial or no evidence from controls testing

OAG Guidance

As our level of evidence from testing the operating effectiveness of controls decreases, the higher the level of evidence we need from substantive procedures. We can achieve this by varying the nature and extent of our testing, i.e.

  • by using tests of details, or a combination of test of details and substantive analytics, rather than only substantive analytics; or

  • increasing the extent of our testing (i.e., by increasing our coverage from targeted testing, or the desired evidence from a sample).

However, a word of caution: if we are unable to place reliance on controls, the information used as the basis for the analytical procedures may be unreliable and accordingly, the analytical procedures will not be effective. In that case, it will be inefficient to perform substantive analytical procedures, and it will be better to focus from the beginning on tests of details.