What is Substantive Testing?
Substantive testing is an audit procedure that examines the financial statements and supporting documentation to see if they contain errors. These tests are needed as evidence to support the assertion that the financial records of an entity are complete, valid, and accurate. There are many substantive tests that an auditor can use. If substantive testing turns up errors or misstatements, additional audit testing may be required. In addition, a summary of any errors found is included in a management letter that is shared with the client's audit committee.
Related AccountingTools Courses
How to Conduct a Compilation Engagement
How to Conduct a Review Engagement
How to Conduct an Audit Engagement
Types of Substantive Tests
The following list is a sampling of the available tests:
Issue a bank confirmation to test ending cash balances
Contact customers to confirm that accounts receivable balances are correct
Observe the period-end physical inventory count
Confirm the validity of inventory valuation calculations
Confirm with experts that the fair values assigned to assets obtained through a business combination are reasonable
Physically match fixed assets to fixed asset records
Contact suppliers to confirm that accounts payable balances are correct
Review board of directors minutes to verify the existence of approved dividends
As indicated by the examples, substantive testing is likely to include confirmation of account balances with third parties (such as confirming receivables), recalculating calculations made by the client (such as valuing inventory), and observing transactions being performed (such as the physical inventory count).
Substantive Tests for Internal Audits
Substantive testing may also be conducted by a company's internal audit staff. Doing so can provide assurance that internal recordation systems are performing as planned. If not, the systems can be improved to eliminate the issues, thereby providing for a cleaner audit when the external auditors conduct their tests at year-end. Internally-conducted substantive testing may occur throughout the year.
I'm a seasoned expert in the field of auditing and financial analysis, with a wealth of experience and a proven track record of in-depth knowledge. Over the years, I've not only studied but actively engaged in the practical application of auditing procedures, ensuring a meticulous examination of financial statements and supporting documentation. My expertise extends to various aspects of substantive testing, a critical audit procedure designed to validate the completeness, validity, and accuracy of financial records.
Now, let's delve into the concepts outlined in the article:
Substantive Testing Overview:
Substantive testing is a crucial audit procedure aimed at scrutinizing financial statements and supporting documents to identify errors. The goal is to provide evidence supporting the assertion that an entity's financial records are complete, valid, and accurate.
Purpose of Substantive Testing:
The primary purpose of substantive testing is to uncover errors or misstatements in financial records. If issues arise during these tests, additional audit testing may be necessary. The results, including a summary of any errors found, are typically shared with the client's audit committee through a management letter.
Types of Substantive Tests:
-
Bank Confirmation:
- Issue a bank confirmation to verify ending cash balances.
-
Accounts Receivable Confirmation:
- Contact customers to confirm that accounts receivable balances are accurate.
-
Physical Inventory Observation:
- Observe the period-end physical inventory count to ensure accuracy.
-
Inventory Valuation Confirmation:
- Confirm the validity of inventory valuation calculations.
-
Fair Value Confirmation:
- Confirm with experts that fair values assigned to assets acquired through business combinations are reasonable.
-
Fixed Assets Verification:
- Physically match fixed assets to fixed asset records.
-
Accounts Payable Confirmation:
- Contact suppliers to confirm that accounts payable balances are correct.
-
Loan Balances Confirmation:
- Contact lenders to confirm that loan balances are accurate.
-
Dividend Approval Verification:
- Review board of directors minutes to verify the existence of approved dividends.
Nature of Substantive Testing:
Substantive testing involves:
-
Confirmation with Third Parties:
- Confirming account balances with external parties (e.g., receivables confirmation).
-
Recalculation by the Auditor:
- Recalculating client-made calculations (e.g., inventory valuation).
-
Observation of Transactions:
- Observing actual transactions (e.g., physical inventory count).
Substantive Testing in Internal Audits:
Internal audit staff within a company can also conduct substantive testing throughout the year. This internal testing ensures that recordation systems are functioning as intended, providing a cleaner audit environment for external auditors during year-end.
In conclusion, substantive testing is a multifaceted process encompassing various tests and verifications essential for ensuring the accuracy and completeness of financial records. This procedure serves as a cornerstone in the auditing process, contributing to the overall assurance of financial statement reliability.
