CHAPTER 3.

AUDIT TESTS

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Contents
• Tests of control for main business cycles

• Substantive procedures
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 References

BPP, ACCA F8 study text:

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• Chapter 9

• Chapter 10

• Chapter 11

Audit Tests
Risk Assessment Used to obtain an understanding of the
entity and its environment, including
Procedures
internal controls.

Tests of Control Directed toward the evaluation of the

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effectiveness of the design and

implementation of internal controls.

Substantive Detect material misstatements in a

Procedures transaction class, account balance, and
disclosure component of the financial
statements. 4

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 Assessment of internal control

• Obtain an understanding and make

preliminary assessment

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• Perform tests of control

Tests of control - Objectives

To obtain audit evidence about the effectiveness of the:

q Design of the internal control systems, ie whether they are

suitably designed to prevent, or detect and correct, material
misstatement at the assertion level; and
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q Operation of the internal controls throughout the period.

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 Tests of Controls – audit
procedures

Enquiry Inspection

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Observation

Reperformance
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Tests of control - procedures

q Inspection of documents supporting controls or events to gain
audit evidence that internal controls have operated properly;
q Enquiries about internal controls which leave no audit trail;
q Reperformance of control procedures;
q Examination of evidence of management views;
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q Testing of internal controls operating on computerised systems

or over the overall IT function;
q Observation of controls to consider the manner in which the
control is being operated

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 Tests of control - main business cycles
• The sales system

• The purchases system

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• The inventory system

• The bank and cash system

• The payroll system

Tests of control - the sales system

The tests of control in the sales system will be based

around:
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• Selling (authorisation)

• Goods outwards (custody)

• Accounting (recording)

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 Tests of control - the sales system

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Sales system
• Occurrence/existence: recorded sales transactions
represent goods or services provided
Controls Tests of controls
Segregation of duties between Observe the process/
sales/dispatch/accounting Discuss with the staff to see if there is
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segregation of duties/

Invoices raised if there are related Check a sample of sales invoices,

approved sales orders and shipping authorized sales order form and
documentation shipping documentation.
Examine application controls for
authorization.
Monthly customer statements sent Review entity's procedures for
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out and customer queries and sending out monthly statements and
complaints handled independently. dealing with customer queries and
complaints.

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Sales system
• Occurrence/existence: goods and services are only
supplied to customers with good credit ratings.
Controls Tests of controls
Authorization of credit terms to - Review entity's procedures for
customers (senior staff authorization, granting credit to customers.

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references/credit checks for new - Review all new customer files to
customers, regular review of credit ensure satisfactory credit references
limits). have been obtained.

Orders not accepted unless credit Examine application controls for credit
limits reviewed first. limits.

To ensure that customers are encouraged Discuss with staff/Review 13

to pay promptly. correspondences

Sales system
• Completeness: all revenue relating to goods
despatched is recorded.
Controls Tests of controls
Accounting for numerical Review and test entity's procedures for
sequences of invoices. accounting for numerical sequences of
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invoices, and inspect invoices to confirm

whether they are sequentially
numbered.
Shipping/despatch documentation is For a sample of shipping/dispatch
matched to sales invoices. documents, ensure each has been
matched to a related sales invoice that
was subsequently recorded
An open-order file is maintained and Inspect the open-order file for unfilled
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reviewed regularly. orders.

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Sales system
• Accuracy: sales and adjustments are correctly journalised,
summarised and posted to the ledger
• Cut-off: transactions have been recorded in the correct period.
Controls Tests of controls

Sales invoices and matching Review supporting documents for a

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documents required for all entries and sample of sales entries to ensure they
the date and reference of the entry contain the written details that
are written on each document. indicate they were referred to when
entered.
- All shipping documentation is Compare dates on sales invoices with
forwarded to the invoicing section on dates of corresponding shipping
a daily basis. documentation.
- Daily invoicing of goods shipped. Compare dates on sales invoices with 15
dates recorded in the sales ledger.

Sales system
• Classification: all transactions are properly classified in
accounts.
Controls Tests of controls
Chart of accounts (COA) in place and is Inspect any documentary evidence of
regularly reviewed for review (such as emails requesting
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appropriateness and updated where update to COA as a result of review).

necessary.
Codes in place for different types of Test application controls for proper
products or services. codes.

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 Tests of control -
the purchases system

The tests of control in the purchases system will

be based around:

Buying (authorization)

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• Goods inwards (custody)

• Accounting (recording)

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Tests of control - the purchases system Banking Academy

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Purchase system
• Occurrence/existence: recorded purchases represent goods
and services received.
Controls Tests of controls
- Authorization procedures and policies in - Inspect/enquire about policies and
place for selecting suppliers, ordering procedures
goods and services. - Observe the processing of
purchase orders.

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- Segregation of duties between - Examine a sample of purchase orders to
ordering/receiving/accounting ensure they have been appropriately
authorized.

- Stores clerks sign for goods received. - Inspect a sample to confirm whether
- Purchase orders and GRNs are matched stores staff undertake this check.
with the suppliers' invoices. - Examine supporting documentation to
ensure it has been matched for a sample
of invoices.

Supplier statements independently Review procedures for reconciling supplier 19

reviewed and reconciled to trade payable statements and reperform a sample of
records. reconciliations.

Purchase system
• Completeness/Obligations: all purchase transactions that
occurred have been recorded/represent liabilities of the
company

Controls Tests of controls

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Purchase orders and GRNs are For a sample of purchase orders in the
matched with the suppliers' invoices. year ensure each has been matched
to a related invoice that was
subsequently recorded.

Periodic accounting for pre-numbered Review entity's procedures for

GRNs and purchase orders. accounting for pre- numbered
documents and inspect a sample of
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GRNs for sequential numbering.

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Purchase system
• Accuracy, valuation and allocation and classification:
Purchase transactions are correctly recorded in the
accounting system.
Controls Tests of controls

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- Mathematical accuracy of the - Review a sample of invoices for
supplier's invoice is verified. evidence the accuracy has been
verified (eg signature or initials) and
- Amount posted to general ledger is reperform the check.
reconciled to the purchases ledger. - Review reconciliations for evidence
of this check.
- Chart of accounts in place. - Review purchases journal and
general ledger for reasonableness.
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Purchase system
• Cut-off: purchase transactions are recorded in the
correct accounting period.
Controls Tests of controls
- All goods received reports forwarded - Compare dates on reports to dates
to accounts payable department daily. on relevant vouchers.
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- Procedures in place that require Compare dates on vouchers with

recording of purchases as soon as dates they were recorded in the
possible after goods/services purchases journal.
received.
- Application controls in the - Tests?
accounting system

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 Inventory system
• Occurrence/existence
Controls Tests of controls
- Authorization procedures and policies - Inspect/enquire about policies and
in place for ordering goods and services. procedures
- Segregation of duties between - Observe the processing of purchase
ordering/receiving/accounting orders.
- Examine a sample of purchase orders to

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ensure they have been appropriately
authorized.
- Stores clerks sign for goods received. - Inspect a sample to confirm whether
- Purchase orders and GRNs are matched stores staff undertake this check.
with the suppliers' invoices. - Examine supporting documentation to
ensure it has been matched for a sample
of invoices.
Supplier statements independently Review procedures for reconciling
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reviewed and reconciled to trade payable supplier statements and re-perform a
records. sample of reconciliations.
Perform inventory count periodically Observe inventory count

Inventory system
• Completeness – Rights and obligations

Controls Tests of controls

- Procedures in place to include - Review entity's procedures
inventory held at third parties and relating to consignment inventory.
exclude inventory held on
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consignment for third parties.

- Reconciliations of accounting - Review reconciliations performed
records with physical inventory. and inspect them for evidence of
review. Re-perform a sample of
reconciliations.

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Inventory system
• Accuracy, valuation and allocation and classification
Controls Tests of controls
- Periodic or annual comparison of Review and test entity's
inventory with amounts shown in procedures for taking physical
continuous (perpetual) inventory inventory.
records.

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- Standard costs reviewed by - Review and test entity's
management. procedures for developing
- Review of cost accumulation and standard costs.
variance reports. - Inspect variance reports
- Inventory managers review produced.
inventory regularly to identify - Discuss with inventory managers
slow-moving, obsolete and excess how this is done. 25
inventory. - Observe the procedure being
performed.

Inventory system
• Cut-off

Controls Tests of controls

- All despatch/goods inward - Inspect documentation to
documents processed daily to confirm daily processing.
record the despatch of finished
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goods.
- Reconciliations of inventory - Review reconciliations
records with general ledger. performed.

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Bank & cash system - Payments
• Occurrence
Controls Tests of controls
- Separate responsibilities for the - Inspect documentation to confirm
recording, payment and reconciliation daily processing.
of cash.
- Supplier statements independently - Review reconciliations performed.

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reviewed and reconciled to trade - Review reconciliations to confirm
payable records. whether undertaken and reviewed.
- Monthly bank reconciliations
prepared and reviewed.
- Only authorised staff can make - Review delegated list of authority for
electronic cash payments and issue cash payments.
cheques. - Inspect relevant documentation for
- Electronic cash payments and evidence of approval by senior
cheques prepared only after all source personnel. 27
documents have been independently
approved.

Bank & cash system - Payments

• Completeness
Controls Tests of controls
- Separate responsibilities for the - Observe the processing of cash
recording, handling and and review the entity's policies to
reconciliation of cash. evaluate whether proper
segregation of duties is operating.
- Supplier statements … - Review procedures …
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- Monthly bank reconciliations … - Review reconciliations …

- Review of cash payments by - Inspect sample of listings for

manager before release. evidence of senior review.
- Daily cash payments reconciled - Review a sample of
to posting to payable accounts. reconciliations for evidence that
- Use of pre-numbered cheques. they have been done.
- Examine evidence of use of pre- 28
numbered cheques.

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Bank & cash system - Payments
• Accuracy, valuation and allocation and classification

Controls Tests of controls

- Reconciliation of daily payments - Review reconciliation, to ensure
report to electronic cash payment performed, reviewed and any
transfers and cheques issued. discrepancies followed up on a
- Supplier statements … timely basis.

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- Monthly bank reconciliations … - Review procedures…
- Review bank reconciliation …
- Payable accounts reconciled to - Review reconciliation, to ensure
general ledger control account. performed, reviewed and any
discrepancies followed up on a
timely basis.
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Bank & cash system - Payments

• Cut-off/Presentation
Controls Tests of controls
- Reconciliation of electronic funds - Review reconciliation and check it is
transfers and cheques issued with carried out regularly.
postings to cash payments journal and
payable accounts.
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- Chart of accounts. - Review cash payments journal to

- Independent approval and review of assess reasonableness of charging of
general ledger account assignment. accounts.
- Review assignment of general ledger
account.

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Bank & cash system - Receipts
• Occurrence
Controls Tests of controls
- Separate responsibilities for the - Review reconciliation and check it is
recording, receipt and reconciliation carried out regularly.
of cash. - Review monthly bank reconciliations
- Monthly bank reconciliations to confirm performed and reviewed.

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performed and independently - Observe cash sales procedures.
reviewed.
- Use of cash registers or point-of-sale
devices.
- Monthly statement sent out
- Periodic inspections of cash sales - Enquire of managers about results of
procedures. inspections.
- Restrictive endorsement of cheques - Observe mail opening, including
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immediately on receipt. endorsement of cheques.
- Mail opened by two staff members. - Observe mail opening procedures.

Bank & cash system - Receipts

• Completeness
Controls Tests of controls
- Separate responsibilities … - Observe …
- Monthly bank reconciliations… - Review monthly bank reconciliations
- Daily cash receipts listing reconciled …
with posting to customer accounts. - Re-perform a sample of the
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reconciliations. Review reconciliation.

- Customer statements prepared and - Enquire of management about

sent out on a regular basis. handling of customer statements.
Examine a sample of customers and
note frequency of statements.

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Bank & cash system - Receipts
• Accuracy, valuation and allocation and classification
Controls Tests of controls
- Daily remittance report - Review reconciliations.
reconciled to control listing of
remittance advices
- Monthly bank statement - Review reconciliations for

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performed and reviewed evidence they were performed
independently. and independently reviewed.
- Monthly customer statements - Review entity's procedures for
sent out. sending out statements.
- Receivables' ledger reconciled to - Review reconciliations.
control account.
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Bank & cash system - Receipts

• Cut-off/Presentation
Controls Tests of controls
- Bank reconciliation at period end. Review and test reconciliation.

- Chart of accounts (COA) in place - Inspect any documentary

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and is regularly reviewed for evidence of review (such as emails

appropriateness and updated requesting update to COA as a
where necessary. result of review).
- Codes in place for different types - Test application controls for
of receipt. proper codes.

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Tests of control – the payroll system

Key controls over payroll cover:

• Documentation and authorisation of staff changes
• Calculation of wages and salaries

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• Payment of wages
• Authorisation of deductions

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Payroll system
• Occurrence
Controls Tests of controls
- Segregation of duties between HR and - Review payroll and HR job descriptions
payroll functions. and company policies.
- Personnel files held for all employees. - Review a sample of starters and leavers
- Authorisation procedures for hiring, in the year to ensure correct
terminating, time worked, wage rates, documentation is in place.
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overtime, benefits etc. - Review and test authorisation

- Any changes in employment status of procedures in place.
employees (eg maternity, special leave) Review policies and procedures in place
informed to HR department. for changing status and consider
whether adequate.
- Use of time clocks to record time - Observe employees' use of time clocks.
worked. - Inspect a sample of clock cards for
- Clock cards approved by supervisor. evidence of approval by appropriate
- Payroll budgets in place and reviewed level of management. 36
by management. - Review budgeting procedures.

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Payroll system
• Accuracy, valuation and allocation and classification
Controls Tests of controls
- Reperformance of a sample of - Review documentary evidence
payroll benefit and deduction that recalculation occurred (eg
calculations. spreadsheet printout).
- Agreement of gross earnings and - Inspect documentation for

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total tax deducted with taxation evidence of management's review.
returns.

- Payroll master file reconciled to - Review reconciliation payroll

general ledger. master file to general ledger.
Confirm whether discrepancies are
followed up promptly and
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resolved.

Payroll system
• Cut-off/Presentation
Controls Tests of controls
All starters, leavers, changes to - Review entity's procedures for
salaries and deductions are reporting changes to the payroll
reported promptly to payroll department.
department and changes are - Verify sample of starters and
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updated in the payroll master file leavers.

promptly.
- Chart of accounts. - Review chart of accounts.
- Independent approval and review - Review procedures for classifying
of accounts charged to payroll. payroll costs.
- Payroll budgets in place and - Review budgeting procedures.
reviewed by management.
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Revenue and capital expenditure
• Authorization
Controls Tests of controls
- Orders for capital items should be - Review policies and procedures
authorised by appropriate levels of in place.
management. - Examine a sample of orders for
- Orders should be requisitioned appropriate authorisation.

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on appropriate (different to
revenue) documentation.
- Invoices should be approved by - Inspect invoices to verify the
the person who authorised the invoice has been appropriately
order. approved.
- Invoices should be marked with - Inspect invoices to verify the
the appropriate general ledger invoice has the correct general
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code. ledger code marked on it.

Revenue and capital expenditure

Classification/Completeness
Controls Tests of controls
- All the standard controls over
purchases are relevant
- Capital items should be written Review reconciliation to ensure it
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up in the non- current asset is regularly carried out, reviewed

register. by a more senior person, and that
all discrepancies are followed up
- The non-current asset register and resolved on a timely basis.
should be reconciled regularly to
the general ledger and any
differences investigated and
resolved promptly. 40

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 Audit Tests
Risk Assessment Used to obtain an understanding of the
entity and its environment, including
Procedures
internal controls.

Tests of Control Directed toward the evaluation of the

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effectiveness of the design and
implementation of internal controls.

Substantive Detect material misstatements in a

Procedures transaction class, account balance, and
disclosure component of the financial
statements. 41

What are substantive procedures?

• Can be used to obtain sufficient appropriate audit

evidence detect material misstatements in the
financial statements. That evidence supports the FS
assertions.
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• They are generally of 2 types:

+ Analytical procedures
+ Test of detail

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Audit assertions with substantive procedures
Audit assertion Typical audit tests

Completeness (a) Review of post year end items

(b) Cut-off testing
(c) Analytical review
(d) Confirmations
(e) Reconciliations to control accounts

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Rights and (a) Reviewing invoices for proof that item belongs to
obligations the company
(b) Confirmations with third parties
Accuracy, (a) Matching amounts to invoices
valuation and (b) Recalculation
allocation (c) Confirming accounting policy is consistent and
reasonable
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(d) Review of post year end payments and invoices
(e) Expert valuation

Audit assertions with substantive procedures

Audit assertion Typical audit tests
Existence (a) Physical verification
(b) Third-party confirmations
(c) Cut-off testing
Occurrence (a) Inspection of supporting documentation
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(b) Confirmation from directors that transactions

relate to business
(c) Inspection of items purchased

Accuracy (a) Recalculation of correct amounts

(b) Third-party confirmation
(c) Analytical review
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 Audit assertions with substantive procedures
Audit assertion Typical audit tests
Classification (a) Confirming compliance with law and accounting
standards
(b) Reviewing notes for understandability
Cut-off (a) Cut-off testing

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(b) Analytical review

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Analytical Procedures (ISA 520)

• "Analytical procedures“ means evaluations of
financial information made by a study of
plausible relationships among both financial
and non – financial data.
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Analytical procedures
Comparisons with:
• Comparable information for prior periods;
• Anticipated results of the entity, from budgets of
forecasts;

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• Expectations prepared by the auditors;
• Industry information.

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Other analytical techniques

• Examining related accounts in conjunction with each
other.
• Trend analysis. Sophisticated statistical techniques
can be used to compare this period with previous
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periods.
• Reasonableness test. This involves calculating the
expected value of an item and comparing it with its
actual value.
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 Analytical Procedures

Analytical
Procedures

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Performance Overall Review
Planning stage
stage stage

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Investigating the results of analytical procedures

• Enquiries of management and obtaining appropriate audit
evidence relevant to management's responses.
• Performing other audit procedures if necessary (eg if
management cannot provide an explanation or the explanation
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is not adequate).

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 Tests of detail
• Tests of detail are procedures design around
verification of transaction within an account
balance to confirm validity of all financial
statement assertions.

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Tests of detail – directional testing Banking Academy

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