Substantive Procedures for the Purchasing Process [Video]

After the auditor has set the achieved level of control risk and determined the risk of material misstatement, the auditor can adjust detection risk. The auditor can decrease detection risk by increasing the nature, timing, and extent of the substantive procedures to be performed.

There are two types of substantive procedures: analytical procedures and tests of details.

Analytical procedures substantiate accounts or disclosures by comparing recorded amounts (or ratios derived from recorded amounts) with the auditor’s independent estimates for those amounts. The auditor arrives at independent estimates by examining relationships between accounts (both financial and nonfinancial) to see if they are plausible. As part of this process, the auditor would:
• Compare financial information to information from comparable prior periods
• Compare financial information to budgeted information
• Examine relationships between related accounts during the period
• Compare financial information to the industry average
• Compare financial information with nonfinancial information

There are two types of tests of details: tests of transactions and tests of account balances.

Tests of transactions are designed to detect fraud or errors in individual transactions. An example would be vouching a sample of journal entries from the purchases journal back to the respective purchase orders, receiving reports, and invoices to verify occurrence.

Tests of account balances, on the other hand, verify the ending balances of accounts. An example would be confirming accounts payable balances with vendors to determine whether the ending balance for accounts payable is fairly stated.

After the substantive procedures have all been performed, the auditor will calculate the aggregate misstatement for accounts payable and related accounts. If the aggregate misstatement is less than or equal to the tolerable misstatement, the auditor will conclude that accounts payable and related accounts are fairly presented. If the aggregate misstatement is more than the tolerable misstatement, the auditor will conclude that accounts payable and related accounts are not fairly presented. In that case, the auditor would want the client to make an adjusting journal entry.

0:00 Introduction
0:28 Substantive procedures and detection risk
0:49 Types of substantive procedures
2:01 Analytical procedures
4:33 Tests of details (tests of transactions)
8:26 Tests of details (tests of account balances)
10:15 Confirmations of accounts payable
11:41 Comparing the aggregate misstatement to the tolerable misstatement
13:13 Auditing disclosures
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