Efficient Tests of Balances Series—No. 2: Results of Risk Assessment Procedures Determine Required Tests of Balances

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The substantive tests of balances normally make the most substantial contributions to accomplishing audit objectives.  Generally, however, the detailed tests of balances are the most costly procedures.  When a reporting entity has good internal control procedures or a good accounting system, high reliance on tests of balances may not normally be the most efficient audit strategy.  On some engagements, often smaller ones, auditing in the least amount of time is usually best accomplished by a combination of risk assessment procedures and detailed tests of balances.  The auditor should always design the most efficient audit strategy based on engagement risks discovered while performing risk assessment procedures!

Risk Assessment Procedures

Risk assessment procedures include all engagement activities from the planning phase up to the development of the audit plan (detailed audit program).  Here is an outline and brief discussion of common risk assessment procedures and related documentation:

1.    Making and documenting client acceptance or continuance decisions.
2.    Reviewing prior year working papers, considering findings and conclusions, adjusting journal entries, uncorrected audit differences and assessing their impact on the current year’s risk assessment.
3.    Reading the current year’s general ledger activity and preparing a memo documenting parameters and findings.
4.    Performing and documenting other preliminary analytical procedures (at least comparing the current year’s unadjusted account balances with prior year adjusted balances).
5.    Preparing flowcharts or memos documenting the client’s accounting and internal control stems and the performance of systems walk-through procedures for major transactions cycles.
6.    Calculating tolerable misstatement by financial statement classification based on risk.
7.    Completing applicable practice aids and other documentation from the firm’s accounting and auditing manuals.
8.    Preparing a linking working paper combining risk of misstatements due to error and fraud to determine the level of risk of material misstatement for relevant assertions in material financial statement classifications.
9.    Designing a detailed audit plan (program) that links significant risks with appropriate procedures (tests of control, analytical procedures and/or detailed tests of balances).

The risk assessment standards make clear that all risk assessment procedures become substantive evidence that contributes toward accomplishing audit objectives.  When considering the evidence necessary to decrease detection risk to an acceptably low level, the performance of risk assessment procedures will reduce the evidence required from other auditing procedures.  

An auditor that is assigned responsibility for performing tests of balances procedures should begin the assignment by reviewing the results of the risk assessment procedures.  The nature, extent and timing of tests of balances procedures must be based on the assessed level of risk of material misstatement for each material account classification.  Effective modification of the audit plan to respond to risks, and the elimination of unnecessary procedures, are the keys to achieving both quality and efficiency on audits! .

My live and on-demand webcasts cover these subjects in detail.  You can download syllabuses and register for my webcasts by clicking the applicable box on the left side of my home page, www.cpafirmsupport.com.


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