7015 Timing of substantive audit procedures

Jul-2013

OAG Guidance

Early testing of an account or class of transactions can provide us with significant audit evidence if no errors are identified in our interim testing. There can be significant benefits to performing substantive procedures prior to the balance sheet date, particularly on those engagements that require the audit to be completed shortly after the balance sheet date and where we have obtained high controls reliance from testing the operating effectiveness of controls. Audit testing prior to the balance sheet date may permit early consideration of significant matters affecting the year end financial statements (e.g., related party transactions, changed conditions, recent accounting pronouncements and financial statement items likely to require adjustment). In addition, much of the audit planning, including obtaining an understanding of internal control, assessing risks and the application of substantive tests to transactions can be conducted prior to the balance sheet date. However, note the Audit cost considerations below.

OAG Guidance

The points below expand on CAS 330.A58. Consider:

• The control environment and other controls—if there are significant changes in the control environment or other controls in the area being audited between the interim date and the year end, we can only rely on those controls if they are retested.

• Whether the information needed to perform interim substantive procedures is available at the interim date.

• The purpose of the substantive procedure—if the purpose is to test, for example, cut‑off at the year end because there are different year end procedures as compared to month end procedures, then perform testing at the year end only.

• The assessed risk of material misstatement—the higher the assessed level of risk, the more likely testing will be performed closer to year end. In addition, if there are specific risks that arise at the year end only, it will only be possible to test those risks at the year end.

• The nature of the significant class of transactions or account balance and related assertions—for example, interim testing of fixed asset additions where there are few transactions in the intervening period may be cost effective compared to testing accounts receivable or inventory balances which turn over multiple times in the intervening period and have high volumes of transactions which may require significant additional testing.

• Whether the client has effective controls over the intervening period (which may require update procedures).

• Consider whether there are rapidly changing business conditions or circumstances that might predispose management to misstate financial statements in the intervening period. If such conditions or circumstances are present, we might conclude that the substantive tests to cover the remaining period would not be effective in controlling the incremental audit risk associated with them. In those situations, the asset and liability accounts affected are generally tested as of the balance‑sheet date.

Obtaining evidence from testing the operating effectiveness of controls is not required in order to have a reasonable basis for extending audit conclusions from the interim date to the balance‑sheet date; however, if we have no evidence from testing controls during the intervening period, consider whether the effectiveness of certain of the substantive procedures to cover that period will be impaired. For example, effective controls may be lacking over the internal documents that provide indications of transactions that have been executed. Substantive procedures that are based on such documents and relate to the completeness assertion for the intervening period may be ineffective because the documents may be incomplete. Likewise, substantive procedures covering the intervening period that relate to the existence assertion at the balance‑sheet date may be ineffective if controls over the custody and physical movement of assets are not present and operating effectively. In both of the above examples, if we conclude that the effectiveness of such substantive procedures would be impaired, we seek additional evidence or re‑examine the accounts as of the balance‑sheet date.

OAG Guidance

The nature of procedures for roll-forward testing include:

† Perform other analytical procedures or substantive tests of details, or a combination of both

‡ Timing can drive level of testing

Achieving a significant level of evidence from testing the operating effectiveness of controls, combined with substantive analytical procedures, may be the most efficient way to test the activity of high transaction volume accounts in the intervening period.

For low volume transaction accounts, targeted testing may provide sufficient appropriate audit evidence over transactions in the intervening period. Other strategies may require significant tests of details, but testing close to the year end may limit the roll‑forward testing.

If it is determined that substantive tests of details is the appropriate test, based upon facts and circumstances, targeted testing of large or unusual items would be the first consideration. If it is determined that audit sampling (statistical or non‑statistical sampling) is the appropriate test of details, you may only need a low level of assurance based upon facts and circumstances including successful interim testing and other testing performed.

We design substantive procedures to cover the intervening period in such a way that the evidence from those tests and the substantive procedures applied to the balance as of an interim date, and any evidence provided from controls, provide sufficient appropriate audit evidence at the balance sheet date.

Such tests ordinarily include

1. comparison of information concerning the balance at the balance‑sheet date with the comparable information at the interim date to identify amounts that appear unusual and investigation of any such amounts; and

2. other analytical procedures or substantive tests of details, or a combination of both, to provide a reasonable basis for extending to the balance‑sheet date the audit conclusions relative to the assertions tested directly or indirectly at the interim date.

We take credit for other audit procedures not specific to roll‑forward testing which can also provide evidence during the roll‑forward period.

The timing of the interim testing will affect the roll‑forward procedures. The further away from balance sheet date, the more evidence (e.g., tests of details) will generally be expected for the intervening period. The following is an example of how this consideration might be applied—professional judgment will be needed:

Interim testing on a 31 December year-end client is performed of an account balance where we assessed our expected controls reliance as partial (where our controls evidence has been obtained from testing business performance reviews):

• 30 September testing (three months from Balance Sheet date): tests of details are generally considered necessary.

• 31 October testing (2 months from Balance Sheet date): tests of details are generally performed on accounts that turn over in less than 60 days.

• 30 November testing (one month from Balance Sheet date): substantive analytics, taken with the evidence from testing controls, may be considered appropriate and after considering the factors mentioned below.

For certain assertions we will likely perform specific procedures at year end anyway (e.g., in respect of cut‑off), while for others (e.g., existence/occurrence) the interim testing and subsequent roll‑forward may be sufficient.

Factors to consider that generally lead to the need to perform tests of details on transactions in the intervening period include:

• significant controls evidence over relevant assertions NOT achieved,

• ineffective design or operation of controls,

• nature of account was such that the intervening period would contain large volumes of transactions which turn over in the intervening period,

• interim period testing was not close to year end,

• misstatements were detected at the interim date,

• inherent, fraud or other significant risks,

• lack of predictability or lack of plausible relationships, and

• rapidly changing business conditions.

Consider if the accounting system will provide information concerning the balances at the balance sheet date and the transactions in the intervening period that is sufficient to permit investigation of:

• significant unusual transactions or entries (including those at or near year‑end);
• other causes of significant fluctuations, or expected fluctuations that did not occur; and
• changes in the composition of the account balances.

If we conclude that evidential matter related to the above would not be sufficient for purposes of controlling audit risk, examine the account as of the balance sheet date.

Where intervening period controls are being relied on

In order to have a reasonable basis for extending audit conclusions from an interim date to the period end, obtain audit evidence about the operating effectiveness of controls in the intervening period. For further guidance, see OAG Audit 6055.

Where intervening period controls are being relied on, but significant evidence from the operating effectiveness of controls has not been achieved

When controls evidence has been obtained, but not high controls reliance, some level of tests of details may be necessary (refer to list of factors above that may influence this judgment). Because some evidence has been obtained from testing controls, the levels of evidence required from the tests of details may be moderate or low.

Where intervening period controls are not relied upon

Where substantive procedures are performed at an interim date, but controls during the intervening period are not tested for operating effectiveness, the level of roll‑forward testing to be performed between the interim date and the year end date will clearly need to be greater than if we were placing reliance on the operating effectiveness of controls. It may be necessary to perform substantive tests of details by performing targeted testing (risk or coverage based) and/or performing audit sampling.

OAG Guidance

If it is known that we cannot obtain significant evidence from the operating effectiveness of controls and it is not practicable or the client is unwilling to introduce special procedures to check the reliability of accounting in the roll‑forward period, reconsider whether interim date testing is efficient. This is because in these circumstances to obtain evidence over transactions in the intervening period and over the year end balance may require tests of details at levels which, when taken together with the amount of work planned at the interim date, are excessive when compared to the amount of work that would need to be done if balance sheet work is done at or much closer to the year end.

OAG Guidance

The assessment of possible misstatement as of the balance sheet date is based on our judgment of the state of the particular account(s) as of that date, after considering:

• the possible implications of the nature and cause of the misstatements detected at the interim date,

• the possible relationship to other phases of the audit,

• the corrections subsequently recorded by the entity, and

• the results of auditing procedures covering the intervening period (including those that are responsive to the particular possibilities for misstatement).