ST.

IGNATIUS
Technical Institute of Business and Arts Inc.
3447 Old National Highway Brgy. Banay-banay City of Cabuyao, Laguna
Tel. No.; (049)- 561-6812 / 0995- 9668-205, e-mail : stignatiuscabuyao@[Link]

CHAPTER 6: SUBSTANTIVE TESTING PROCEDURES

Auditing Standards References (PSAs)

• PSA 500 – Audit Evidence
• PSA 501 – Audit Evidence: Specific Considerations for Selected Items
• PSA 505 – External Confirmations
• PSA 520 – Analytical Procedures
• PSA 540 (Revised) – Auditing Accounting Estimates, including Fair Value Accounting Estimates and
Related Disclosures

I. Introduction to Substantive Testing

After assessing inherent risk and control risk, the auditor performs substantive tests to reduce detection risk to an
acceptably low level. Substantive testing is a direct response to the possibility that material misstatements may exist in the
financial statements.
In practice, even when internal controls are assessed as strong, the auditor cannot eliminate substantive testing. This
reflects the professional view that:
• Risk assessment is judgmental and may not identify all misstatements; and
• Internal controls have inherent limitations.

II. Meaning and Purpose of Substantive Tests

Definition
Substantive tests are audit procedures designed to detect material misstatements at the assertion level.
Key Characteristics
• They provide direct evidence about the correctness of account balances, transactions, and disclosures.
• They support the validity of management’s assertions (existence, completeness, accuracy, valuation, rights and
obligations, and presentation).
• Because they validate balances and transactions, they are also called validation procedures.
Forms of Substantive Procedures
1. Tests of details
2. Substantive analytical procedures

III. Mandatory Nature of Substantive Procedures

Substantive procedures are required for all relevant assertions relating to:
• Each material class of transactions
• Each material account balance
• Each material disclosure
Important Points
• Substantive testing cannot be eliminated.
• The extent of substantive testing may be reduced when the auditor relies on effective internal controls.

IV. Nature, Timing, and Extent of Substantive Tests

The design of substantive procedures depends heavily on the results of tests of controls.
1. Nature
Refers to the type and quality of audit procedures performed.
• More effective procedures = higher quality evidence
Example:
• Bank confirmations (high quality)
• Inquiry of client personnel (lower quality)
2. Timing
Refers to when audit procedures are performed.
• Interim testing
• Year-end testing
Example:
• Inventory count at year-end provides stronger evidence than counts done months earlier.
3. Extent
Refers to the quantity of evidence, often measured by sample size.
• Higher risk → larger sample size

V. Relationship Between Tests of Control and Substantive Tests

• There is an inverse relationship between reliance on internal control and reliance on substantive testing.
• Tests of control indicate whether misstatements are likely to occur.
• Substantive tests indicate whether misstatements actually exist.
Example
If tests of controls reveal ineffective authorization procedures:
• The auditor assumes misstatements are likely.
• More extensive substantive testing is required.
Dual-Purpose Tests
A single procedure may serve both purposes.
Example:
• Examining an invoice to verify:
o Proper approval (test of control)
o Validity of the transaction (substantive test)

VI. Types of Substantive Procedures

 ST. IGNATIUS
Technical Institute of Business and Arts Inc.
3447 Old National Highway Brgy. Banay-banay City of Cabuyao, Laguna
Tel. No.; (049)- 561-6812 / 0995- 9668-205, e-mail : stignatiuscabuyao@[Link]

A. Tests of Details
Tests of details involve direct examination of transactions, balances, and disclosures.
1. Tests of Details of Transactions
Purpose:
• To verify transactions that give rise to account balances
Common Techniques:
• Tracing
• Vouching
Applicability:
• Accounts with relatively few but material transactions
Examples:
• Property, Plant and Equipment (PPE)
• Bonds payable
• Capital accounts
2. Tests of Details of Balances
Purpose:
• To obtain direct evidence about ending account balances
Characteristics:
• Usually the most costly type of substantive test
• Provides the most persuasive evidence
Applicability:
• High-volume accounts with many small transactions
Examples:
• Cash
• Accounts receivable
• Inventory

B. Substantive Analytical Procedures

Substantive analytical procedures involve evaluating plausible relationships among financial and non-financial data.
Key Features:
• Based on expectations developed by the auditor
• Provide circumstantial, not conclusive, evidence
• Least costly audit tests
Examples:
• Comparing gross profit percentages across periods
• Analyzing trends in operating expenses
• Ratio analysis (e.g., inventory turnover)
Limitations:
• Differences may arise from valid reasons
• Always require follow-up investigation

VII. Directional Testing

Directional testing focuses on the direction of possible misstatement.
1. Tracing
• From source documents → accounting records
• Tests completeness
• Detects understatement
Example:
• Tracing shipping documents to sales journal
2. Vouching
• From accounting records → source documents
• Tests existence or occurrence
• Detects overstatement
Example:
• Vouching recorded sales to delivery receipts

VIII. Audit Evidence

Definition
Audit evidence refers to all information used by the auditor in forming the audit opinion.
Relationship with Assertions
Audit evidence includes:
• Information that supports management assertions
• Information that contradicts management assertions

IX. Nature and Types of Audit Evidence

A. Accounting Records
• Journals and ledgers
• Supporting documents
• Adjusting entries
• Worksheets and schedules
B. Corroborating Evidence
• External confirmations
• Bank statements
• Contracts and minutes
 ST. IGNATIUS
Technical Institute of Business and Arts Inc.
3447 Old National Highway Brgy. Banay-banay City of Cabuyao, Laguna
Tel. No.; (049)- 561-6812 / 0995- 9668-205, e-mail : stignatiuscabuyao@[Link]

• Industry data
C. Types of Evidence
• Physical evidence (inventory counts)
• Mathematical recomputation
• Documentation
• Confirmations
• Client representations
• Analytical procedures

X. Reliability of Audit Evidence

Factors Affecting Reliability
• Source (external > internal)
• Nature (documentary > oral)
• Circumstances obtained
• Strength of internal controls
Hierarchy of Reliability (Most to Least Reliable)
1. Auditor’s direct knowledge
2. External evidence sent directly to auditor
3. External evidence held by client
4. Internally generated, externally circulated
5. Internally generated, not circulated
6. Oral evidence

XI. Sufficiency and Appropriateness of Audit Evidence

Sufficiency
• Refers to quantity of evidence
Influenced by:
• Risk of misstatement
• Materiality
• Quality of evidence
Appropriateness
• Refers to quality of evidence
• Determined by relevance and reliability

XII. Audit Documentation (Working Papers)

Definition
Audit documentation records:
• Procedures performed
• Evidence obtained
• Conclusions reached
Purposes
• Support audit opinion
• Demonstrate compliance with PSAs
• Aid supervision and review
• Provide legal defense

XIII. Types of Audit Files

Permanent File
• Long-term information
• Contracts, charters, internal control documentation
Current Audit File
• Financial statements
• Audit programs
• Trial balances
• Supporting schedules

XIV. Ownership and Confidentiality of Working Papers

• Working papers are the property of the auditor (RA 9298).
• They are confidential and privileged.
• Disclosure allowed only under specific legal or professional circumstances.

XV. Auditing Accounting Estimates (PSA 540 Revised)

Definition
An accounting estimate is an approximation used when precise measurement is not possible.
Examples
• Allowance for credit losses
• Inventory obsolescence
• Depreciation
• Warranty provisions
• Fair value estimates
Auditor’s Responsibilities
• Evaluate competence, capability, and objectivity of management’s expert
• Understand assumptions and methods
• Assess reasonableness and consistency of estimates
 ST. IGNATIUS
Technical Institute of Business and Arts Inc.
3447 Old National Highway Brgy. Banay-banay City of Cabuyao, Laguna
Tel. No.; (049)- 561-6812 / 0995- 9668-205, e-mail : stignatiuscabuyao@[Link]

SUMMARY
Substantive testing is the core of the audit process, providing direct and persuasive evidence on which the auditor bases
the audit opinion. Its effectiveness depends on proper judgment in selecting the nature, timing, and extent of procedures
and in evaluating the sufficiency and appropriateness of audit evidence.

QUIZ 1 ANSWER KEY:

No. Ans Explanation
1 B Substantive procedures directly detect misstatements at assertion level.
2 C PSAs require substantive procedures for all material assertions.
3 B Internal controls have inherent limitations.
4 C Nature refers to type and quality of audit procedures.
5 C Timing refers to when procedures are performed.
6 B Extent relates to quantity, commonly sample size.
7 C More reliance on controls means less substantive testing.
8 B Controls indicate likelihood, not existence, of misstatements.
9 C Dual-purpose tests serve both objectives.
10 C One procedure tests both control and validity.
11 B Tests of details identify misstatements in amounts.
12 C They focus on individual transactions.
13 B Few but material transactions suit transaction testing.
14 C PPE involves few but material transactions.
15 C They directly test ending balances.
16 C Costly but highly persuasive.
17 B High turnover accounts focus on ending balance.
18 B Analytical procedures rely on expected relationships.
19 C They provide circumstantial evidence.
20 C Expenses like utilities are predictable.
21 B They are least costly to perform.
22 C Differences require investigation, not immediate conclusion.
23 C Tracing tests completeness.
24 B Vouching tests existence/occurrence.
25 B Tracing detects understatement.
26 C Vouching detects overstatement.
27 C Evidence may support or contradict assertions.
28 C Confirmations are corroborating evidence.
29 C Recomputation verifies mathematical accuracy.
30 C Direct auditor observation is most reliable.
31 B Direct evidence is more reliable.
32 D Oral evidence is least reliable.
33 C Sufficiency concerns quantity.
34 B Appropriateness = relevance + reliability.
35 B Higher risk requires more evidence.
36 C Estimates arise from uncertainty.
37 B Allowance for credit losses is an estimate.
38 B PSA 540 requires these evaluations.
39 C Documentation supports auditor’s opinion.
40 C RA 9298: working papers belong to the auditor.