Increasing Audit Profits Series No. 34—Maximizing Substantive Evidence from Reading (Scanning) the General Ledger
One of the most pervasive analytical procedures is reading, or scanning, the general ledger account activity. Whether done manually, or with the assistance of data extraction software, this analytical procedure is discussed for the first time in professional standards in SAS Nos. 106 and 109.
Many auditors customarily perform this procedure but fail to consider its affect on their audit strategy. After any errors are corrected by proposed journal entries, the auditor has obtained significant, substantive evidence that relevant assertions for many account balances are reasonable. The evidence obtained from this risk assessment procedure should enable the auditor to reduce the assessed level of risk of material misstatement and, therefore, the extent of evidence desired from detailed tests of balances.
This procedure is usually performed by looking for (1) unusual amounts or postings, (2) transactions or general journal entries greater than the lower limit for individually significant items, (3) checks or disbursements to be used in support tests, and (4) other unusual matters. Documentation of the procedure should include the parameters of the test, the exceptions the test revealed and the resolution of the exceptions in a spreadsheet, memo or other working paper.
Most auditors scan the reporting entity’s general ledger to gain familiarity with the accounting system and to identify potential risks of misstatements. As a common practice for decades, potential risks of misstatements were generally documented on working papers pertaining to applicable account classifications. When the potential risks were adequately explained, little or no documentation of related inquiries or substantive tests were retained in the working papers. When the potential risks were determined to be errors, they became the subject of proposed journal entries or were entered on error analysis forms.
SAS No. 103, Audit Documentation, requires documentation of all substantive evidence that is part of an audit strategy. In fact, the overarching principle of this standard is that audit documentation must be sufficient to enable an experienced reviewer to understand what the auditor did, what was found and what was done about what was found (my paraphrase).
Because reading the general ledger produces large amounts of substantive evidence that contributes to cost-beneficial audit strategies, documentation should include:
• Memo or working papers descriptions of the process
• Identification of all transactions and balances selected for inquiry or other substantive tests
• Client personnel responses to inquiries
• The results of additional substantive tests and auditors’ actions and conclusions regarding all unusual items selected for consideration
For live and on-demand webcasts discussing this and other risk assessment procedures, click the applicable box on the left side of my home page, www.cpafirmsupport.com.