Solutions manual
to accompany
Audit and assurance
2 edition
nd
by
Leung et al.
© John Wiley & Sons Australia, Ltd 2023
, Chapter 8: Gathering Substantive Evidence
Chapter 8: Gathering Substantive Evidence
Review questions
8.11 Identify the three types of substantive procedures and discuss the
effectiveness of each.
Substantive analytical procedures consist of the study and comparison of
relationships among data. These procedures have proven quite effective in
detecting large misstatements in the financial reports and tend to be the least
costly of substantive procedures.
Tests of details of transactions primarily involve tracing and vouching the
individual debit and credit entries in the account. When these procedures
involve highly appropriate evidence such as externally generated documents,
they can be quite effective. They tend to be more costly than analytical
procedures, but less costly than tests of details of balances.
Tests of details of balances verify the ending account balances directly, without
any explicit reference to the individual debit and credit entries. These
procedures tend to be the most effective and costly since they often involve the
most reliable forms of evidence such as auditor observation and confirmation
from outsiders.
8.12 Why are cut-off tests a special category of tests of details of
transactions?
Cut-off tests are a special category of tests of details of transactions that are related
more to the closing balance than to transactions. It is only at balance sheet date that it
is important to ensure that transactions are properly recorded before or after the year-
end. Because cut-off is critical only once a year, control procedures are rarely effective
and are usually monitored directly by senior accounting personnel. Cut-off is one of
the financial statement assertions which has elements of (1) completeness (in that all
transactions occurring before the balance sheet date are recorded) and (2) occurrence
(in that transactions occurring after the balance sheet date are excluded). Cut-off errors
can significantly affect profit. For example, goods received before balance sheet date
and included in inventory, but not recorded in purchases until after the year-end, will
overstate profit by the amount of the purchases.
© John Wiley and Sons Australia, Ltd 2023 8.2
, Solutions manual to accompany Audit and assurance 2e by Leung et al.
8.13 Explain why there is an increased audit risk from conducting
procedures before the end of the reporting period and identify two
ways in which this increased risk is controlled.
There is an increased risk associated with performing substantive procedures before
the end of the reporting period as there is an increased risk that material misstatements
existing in the account at the end of the reporting period will not be detected. This risk
becomes greater as the time period remaining between the date of the interim report
and the end of the reporting period is lengthened.
The potential increased audit risk can be controlled if:
The internal control structure during the remaining period is effective.
There are no conditions or circumstances that may predispose management to
misstate the financial statements in the remaining period.
The year-end balances of the accounts examined at the interim date are
reasonably predictable as to the amount, relative significance and composition.
The entity’s accounting system will provide information concerning significant
unusual transactions and significant fluctuations that may occur in the remaining
period.
8.14 Why may an auditor decide to perform tests of details on income
statement accounts rather than relying on analytical review?
When the evidence obtained from substantive analytical procedures and from tests of
details of related balance sheet accounts does not reduce detection risk to an
acceptably low level, direct tests of details of assertions pertaining to profit and loss
statement accounts are necessary. This may be the case when:
inherent risk is high;
control risk is high;
analytical procedures reveal unusual relationships and unexpected fluctuations;
and
the account requires analysis.
Accounts requiring separate analysis include:
legal expenses and professional fees;
maintenance and repairs;
travel and entertainment; and
directors’ remuneration.
8.15 What additional procedures might an auditor need to perform when
it is the first time they have audited a specific client?
For initial engagements, an auditor will need to assess:
• whether opening balances contain misstatements that materially affect the current
period’s financial report, and
• whether appropriate accounting policies reflected in the opening balances have been
consistently applied in the current period’s financial report, or changes in policies are
© John Wiley and Sons Australia, Ltd 2023 8.3
to accompany
Audit and assurance
2 edition
nd
by
Leung et al.
© John Wiley & Sons Australia, Ltd 2023
, Chapter 8: Gathering Substantive Evidence
Chapter 8: Gathering Substantive Evidence
Review questions
8.11 Identify the three types of substantive procedures and discuss the
effectiveness of each.
Substantive analytical procedures consist of the study and comparison of
relationships among data. These procedures have proven quite effective in
detecting large misstatements in the financial reports and tend to be the least
costly of substantive procedures.
Tests of details of transactions primarily involve tracing and vouching the
individual debit and credit entries in the account. When these procedures
involve highly appropriate evidence such as externally generated documents,
they can be quite effective. They tend to be more costly than analytical
procedures, but less costly than tests of details of balances.
Tests of details of balances verify the ending account balances directly, without
any explicit reference to the individual debit and credit entries. These
procedures tend to be the most effective and costly since they often involve the
most reliable forms of evidence such as auditor observation and confirmation
from outsiders.
8.12 Why are cut-off tests a special category of tests of details of
transactions?
Cut-off tests are a special category of tests of details of transactions that are related
more to the closing balance than to transactions. It is only at balance sheet date that it
is important to ensure that transactions are properly recorded before or after the year-
end. Because cut-off is critical only once a year, control procedures are rarely effective
and are usually monitored directly by senior accounting personnel. Cut-off is one of
the financial statement assertions which has elements of (1) completeness (in that all
transactions occurring before the balance sheet date are recorded) and (2) occurrence
(in that transactions occurring after the balance sheet date are excluded). Cut-off errors
can significantly affect profit. For example, goods received before balance sheet date
and included in inventory, but not recorded in purchases until after the year-end, will
overstate profit by the amount of the purchases.
© John Wiley and Sons Australia, Ltd 2023 8.2
, Solutions manual to accompany Audit and assurance 2e by Leung et al.
8.13 Explain why there is an increased audit risk from conducting
procedures before the end of the reporting period and identify two
ways in which this increased risk is controlled.
There is an increased risk associated with performing substantive procedures before
the end of the reporting period as there is an increased risk that material misstatements
existing in the account at the end of the reporting period will not be detected. This risk
becomes greater as the time period remaining between the date of the interim report
and the end of the reporting period is lengthened.
The potential increased audit risk can be controlled if:
The internal control structure during the remaining period is effective.
There are no conditions or circumstances that may predispose management to
misstate the financial statements in the remaining period.
The year-end balances of the accounts examined at the interim date are
reasonably predictable as to the amount, relative significance and composition.
The entity’s accounting system will provide information concerning significant
unusual transactions and significant fluctuations that may occur in the remaining
period.
8.14 Why may an auditor decide to perform tests of details on income
statement accounts rather than relying on analytical review?
When the evidence obtained from substantive analytical procedures and from tests of
details of related balance sheet accounts does not reduce detection risk to an
acceptably low level, direct tests of details of assertions pertaining to profit and loss
statement accounts are necessary. This may be the case when:
inherent risk is high;
control risk is high;
analytical procedures reveal unusual relationships and unexpected fluctuations;
and
the account requires analysis.
Accounts requiring separate analysis include:
legal expenses and professional fees;
maintenance and repairs;
travel and entertainment; and
directors’ remuneration.
8.15 What additional procedures might an auditor need to perform when
it is the first time they have audited a specific client?
For initial engagements, an auditor will need to assess:
• whether opening balances contain misstatements that materially affect the current
period’s financial report, and
• whether appropriate accounting policies reflected in the opening balances have been
consistently applied in the current period’s financial report, or changes in policies are
© John Wiley and Sons Australia, Ltd 2023 8.3
