 In this presentation, we will discuss types of audit tests, keeping the overall audit objective in mind, the overall audit objective to give an opinion on. Support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need then can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. The financial statements to see whether or not those financial statements are free of material misstatement. As we go through the types of audit tests, we're going to break down that process to specific things that we are testing. We may be testing internal controls, we may be testing other types of assertions, and we want to make sure that as we think about these tests, we are thinking about what is the thing that we are testing? Are we testing the internal controls? Are we testing specific assertions? Are we testing specific assertions related to specific type of accounts? We'll get into this in more detail as we start to go through each component of the audit, but we want at this point to get an overview of the types of tests within the audit. So types of audit tests, we have a risk assessment procedures used to attain an understanding of the entity and its environment, including an understanding of internal controls. So when we're testing for risk assessment, risk assessment procedures, we're trying to get an understanding of the entity, we're trying to get an understanding of the internal controls. The test of controls then is going to evaluate the effectiveness of the design of the operation of internal controls. Really big process when we talk about large type of companies, the internal controls something that we have to rely on, and therefore we will be testing the controls directly. One reason we do so is because testing the controls allows us to rely on the controls, if the controls are strong, and that allows us to do less substantive testing, which should save us time. If we had to do substantive testing, testing the actual accounts, then and have a high level of testing there, it would take a lot more time than us to be able to determine that the level of controls are high enough that we can do less substantive testing. So that's going to be one of the goals that we have. Then the substantive procedures will be detect material misstatement in transaction class, account balance, and disclosure component of the financial statements. And this again is usually what most people think of. If you were to think of an audit and you were just going to jump in and say, let's audit this thing. Let's take a look and make sure these financial statements are materially correct. You'd probably say, give me those financial statements and let's just start going right through the accounts cash, accounts receivable, whatnot. Well, that's basically the substantive type procedures. You may do that in a small type of audit and that might be somewhat of an effective way to go. But the larger the audit gets, the more we have to depend on the internal controls, because taking that approach would involve of just going straight to the substantive testing, testing the actual account balances is going to take too much time. So just note that there's always going to be that emphasis, especially here as we're emphasizing the audit of the larger type of businesses, publicly traded companies. And then once you peel that back down to smaller types of companies, you would expect the internal controls to be weaker and the substantive tests then to be something that you possibly have to do more of test of controls include inquiry. So that's going to be the appropriate management supervisor and staff personnel who are we're obviously going to be asking questions about. That's going to be one of the types of tests of control. As we think of the test of control, you might want to think about, well, how reliable are these types of things and start to think as we think of our detective type work, how high on the list of evidence are these types of things that we're looking at. Obviously, inquiry is something that we have to do because that's going to give us an understanding. But who are we inquiring on the management, the supervisor and the staff? And of course, that's also the people that we are judging in some way or giving some type of opinion on as to whether the financial statements are put together well. So note that we have to depend on these things because we have to get an idea of the internal controls. But in the list of evidence, the inquiry as compared to like third party type of information, something outside the company, not prepared by management, would be higher on the scale. So just note that we need to have inquiry. But of course, we can't have inquiry in and of itself as usually the only type of evidence for many types of things, especially for the complete audit process. Then we have inspection, inspection of documentation, reports and electronic files. So we can actually go in and inspect. We have observation of the application of specific controls. So when we think about controls, of course, we can inspect the documentation to see if those controls are being done. We can go in and observe and note controls are going to be kind of like a bureaucracy. They're going to be a system of things that have to be done, usually things that people might complain about, right? They're going to have more types of tests, more types of separation of duty, more type of documentation that has to be stamped as it goes through and approval processes happening. We can actually go through the process and see whether or not and observe whether or not these things are happening because note that controls are things that you could eliminate a lot of times in a particular type of transaction and it may actually speed up the transaction. Not having a separation of duties, in other words, could make it faster to complete the process. However, the risk would be higher that there's going to be some type of fraud or some type of problem, potential problem could happen there. Therefore, we have the internal controls as the businesses get larger. It's quite possible that the controls are set in place. Good controls are set in place. They're all mapped out. You have a good plan of controls, but they're not implemented. They've gotten weak. People are not going to the controls because they're short cutting the controls because they don't see the purpose of the controls. We would catch that. We could see that if we go through the observation and that we could clearly happen. We could basically say, hey, these are the controls. You're supposed to have this checked off by this person. There's supposed to be some supervisory check and you're not doing that. Why? The explanation could be, well, because that takes more time. We have to do it because it's going to lower the risk of problems happening. We can go through and observe that. We can have a re-performance, which is the application of the control by the auditor. We can actually re-perform some of the controls and see if they are indeed done in accordance with our re-performance. Just to double check, take a sample and re-perform and double check. A walkthrough is where we're actually going to be tracing a transaction from its orientation to its inclusion in the financial statements through a combination of audit procedures like inquiry, observation, and inspection. Then we're usually going through a few different processes following something through a few different processes and using whatever we need to use in order to follow that process from the orientation to where it falls or where it finally ends up on in the financial statements. Here's just some examples of test of controls, examples. This is the internal control. This is the test of controls. Remember, internal controls are things like the company has some kind of bureaucracy, some kind of process that they're having in order to safeguard against problems, things like fraud, things like theft of the employee, things like misrepresentation or misreporting of types of things. They set up these internal controls. We want to know what those internal controls are, so we're going to ask about them and then they're going to tell us about them and they're going to try to tell us that they have good, strong internal controls because that's what we want to hear as the auditor, of course. Then we're going to go in and we're going to test the internal controls to see if not only they know what good, strong internal controls are, that they've mapped out the good, strong internal controls but that they're actually implementing the good, strong internal controls. We're going to have to test the internal controls, not the account balances now. We're testing whether or not they're going through the processes, the controls, the checks and balances in their system, which we believe will heighten the ability for them to have financial statements that are not materially misstated. We have the separation of duties between the shipping function and the order entry and billing. This is a common type of internal control separation of duties. Well, how can we check to see if there's a separation of duties between the shipping function and the order entry? Well, we could observe and evaluate whether the shipping personnel has access to the order entry and billing. Notice the shipping person shouldn't have access to the order entry and the billing. That's the separation of the two. Now, if they do, it would be easier because the shipping person could do the two jobs at the same time possibly and possibly save time. The point is that you want two different people to be involved in those different things so that if they wanted to have theft or some type of problem happened, they would have to collude. Therefore, that's how we can test basically whether or not that separation is taking place. It's quite possible, again, that it doesn't take place and the control isn't followed. It could happen and not even that there's a fraud happening or that there's theft happening. They might just say, hey, this control was taking too much time and we took it out. Then, of course, we're going to say, well, the internal control needs to be in place so that we've reduced the likelihood of fraud. That's going to go towards whether or not the management is actually enforcing the internal controls that are in place that they have set up in order to do these things. Credit department personnel, initial sales order indicating credit approval. Are they initially to indicate that there is credit approval? We can inspect the sales orders for presence of initials of credit department personnel. Obviously, there's going to be an approval process. They're going to stamp it off with the initials of some kind saying that there was a credit approval. We can go through the sample of the sales order and see if the initials are indeed there. Again, we looked at the internal control process. They say that they checked this to see that they had a process for the approval check and we go through and test the documentation to see not only that they're documenting that as an internal control, but they're actually at least stamping off some of these documentations given an indication that they're following through with that internal control. Billing department personnel account for the numerical sequence of the sales invoices. The sales invoices in a numerical sequence, we can inquire of the bill in personnel about missing sales invoice numbers. If we inquire the billing department and they say, I don't know what do you mean about invoice numbers at all or what, then that would be an indication that they're not really checking for the missing sales invoice numbers. They should have an idea of what type of invoice numbers have been misstated and maybe have a list of them possibly. Tell us about the missing sales numbers. Agree sales invoice to shipping document and customer order for product types, price, and quantity. This is a common type of process and control we're going to have. We're going to agree the sales invoice. We have the sales invoice to the shipping document. That's when the shipping actually goes out and the customer order. We have three documents that should be basically tied together and we're going to basically want to agree those three documents. How can we check that? We can recompute in this case the information on a sample of sales invoices. These are just some tests that we can take a look at. We'll take a look at more types of tests in the future. These are tests, remember, of the internal controls and example of them. Then we have the substantive procedures. Now, the substantive procedures are typically what are going to happen later on in the audit because, of course, that happens after we test the controls and we'll go through this in the planning process when we discuss this more, but we're going to test the controls to see if they're high or low. Then we're going to determine how many substantive tests we need and go through the substantive tests as efficient a way as possible. These are usually the longer tests, but also the ones that are most familiar, the ones that we would think about. Again, if you were just doing to jump into the audit, you'd probably think I'd be starting to think about substantive type testing if you were going to try to test the accounts of the financial statements. Tests of details, tests of errors or fraud in individual transactions, account balances, and disclosures. We're just going to go right in there. We're going to give me those account balances, give me those disclosures, give me that general ledger, and we're going to go in and start trying to test these transactions. Again, publicly traded company, a lot of transactions, a lot of things to test. We would like to limit the amount of testing as much as possible. How do we do that? We hopefully can increase the, how to say, the controls are high and therefore less substantive testing. Analytical procedures, also substantive testing. Evaluate of financial information through analysis of plausible relationships among financial and non-financial data. Now the analytical procedures, I would often think of the analytical procedures as the things that you can do more in the office. You can basically compare the financial statements last year to this year. You can see if they went up. You can compare it to different type of industries. You can see if there's substantial changes in those type of numbers. A lot of times when you think of analytical procedures, you're thinking these are the auditors in their own office with the financial statement basically comparing the numbers, looking for changes in the ratios and whatnot. As a shortcut, I would kind of think of analytical procedures as the things that the auditor could do in basically their own office as opposed to other types of tests where they would have to go out to the customers or to the client and actually start digging up invoices and whatnot and looking at physical documentation, possibly start counting things and counting inventory and that type of stuff. Analytical procedures, evaluation of financial statements, information through analysis of plausible relationship among financial and non-financial data. Then we have dual-purpose tests. It often makes sense to design audit procedures to conduct both a test of controls and substantive tests of transactions simultaneously on the same document. Whatever we can do this, we're obviously very excited. This is a very exciting thing. If we can have a dual-purpose test, in other words, if we could test the controls and do the substantive tests with the same procedure, we're going to try to design the audit to do that as much as possible because that will save us time. You'll recall that we're going to test the controls typically first, test whether the controls are high or low, and then design and think about how many substitutes, tests we need to do, those tests usually taking more time and therefore we want to reduce how many of them there are. So as we think of the tests of controls, however, good planners, as we are of the audits, we're always going to be thinking forward and say, hey, as we're doing these tests of controls, can we also document and do some of the substantive tests at the same time, considering we're digging into these particular areas of work as we think about the tests of control. Anytime we can do that, we do do that because that, of course, will save time once we complete the test of controls, go to the substantive tests. As we go to the substantive tests, we're going to say, hey, we've already tested some of these a little bit because we did that during the test of controls and we documented that out. That's going to save us some time, save us some money and make us happy.