Are You Taking Credit for All Your Substantive Auditing Procedures?
The risk assessment standards tell us that all risk assessment procedures produce substantive evidence. If this is true, and it is, planning activities, brainstorming meetings, inquiries of client management and employees, documenting internal control and the evaluation of risks of material misstatements all produce substantive evidence.
So how much substantive evidence is necessary for an audit engagement? We know the answer depends on the risks at the financial statement and assertion levels. Being the conservative souls that we are, however, we usually collect more than enough substantive evidence to mitigate engagement risks! We can achieve quality this way but we may not be able to bill for all our time charges!
So, to our question. Are you taking credit in your audit strategy and audit plan for all that you do on audits? If all risk assessment procedures produce substantive evidence, and we require a certain amount of substantive evidence at a given risk level, are we considering reductions in our detailed tests of balances as a result of the addtional evidence from risk asssessment procedures? Raising the lower limit for individually significant items, eliminating a few accounts reveivable confirmations, only reviewing bank statements for reasonableness, or reducing the number of days used in cut-off tests are just a few examples of reductions in detailed tests of balances.
One of the most pervasive analytical procedures we routinely perform is reading the general ledger. Whether it's done manually or with data extraction software, this analytical procedure produces HUGE amounts of substantive evidence. Looking for unusual amounts or postings, transactions or journal entries greater that the lower limit for individually significant items, checks or disbursements to be used in support tests and other unusual matters enables the auditor to identify risks of misstatements and to provide any necessary audit responses, including proposing journal entries to correct errors. The problem is that we don't always consider the effects of what we didn't find on our audit strategy and audit plan!
Activity in an entity's general ledger that is accounted for correctly is substantive evidence that contributes evidence for he auditor's opinion about the fairness of presentation of the entity's financial statements. Many auditors customarily perform this procedure but fail to consider its effects on their audit strategy and audit plan. The substantive evidence obtained from this and other risk assessment procedure may enable the auditor to reduce the assessed level of risk of material misstatement to less than high. When the level of risk is less than high, the extent of evidence required from detailed tests of balances procedures is also less. Taking credit for the substantive evidence provided from our risk assessment procedures can reduce our detailed tests of balances and our engagement time charges!
I've attached an illustration comparing tests of balances procedures at various levels of risk for your downloading and use. If you have questions about this illustration, or any of the information I present in this blog, please go to our website, www.cpafirmsupport.com, and send me a contact question or comment.
by Larry Perry, CPA, CPA Firm Support Services, LLC - Larry has over 40 years experience as a CPA practitioner, author of accounting and auditing manuals, author and presenter of live staff training seminars and author of webcast and self-study CPE programs. He is co-founder of CPA Firm Support Services, LLC (www.cpafirmsupport.com), an organization providing resources, training and consulting to smaller CPA firms. Larry writes a weekly blog on AccountingWEB.com focusing on small audits, reviews and compilations. He is currently developing documentation manuals and handbooks for small audits, reviews and compilations and related electronic practice aids.