Unit Essay Example



Question 1

Tests of controls are designed mainly to gauge the effectiveness of the existing controls in a firm and control risk that are conducted by an auditor. They also aim to obtain substantial evidence that will act as a support material for the auditor’s opinion with regards to the internal control of the firm when it comes to financial reporting. The opinion of the auditor should be formed once the evidence has been sought on the operations of the firm and their level of effectiveness. A time frame must exist sufficient enough to incorporate all the tests of controls performed so as to achieve an objective opinion on the financial reports. For instance, an auditor may choose to select a given control that was carried out by a client during that period of time to ensure their operation was effective. During assessment of the financial reports, in the event of misstatements that happened to be uncorrected, the auditor as administering a test of control would have to source for evidence on the authorization of these reports by looking for signatures and stamps. It basically ensures that the internal controls in a firm are working.

Substantive testing on the other hand are certain procedures undertaken by an auditor so as to determine any possible misstatements that could be in existence in the financial statements. This is done at the end of a given period of time. This is typically ensuring that the numbers provided in the financial statements actually match to the source documents and meet the audit assertions. The auditor does not test every single number but based on a sample that was selected that could be based on an opinion or risk. An example of a substantive test would be a case of a budget. An auditor would actually conduct a test by selecting a sample on given activities that were stated in the budget in that particular period of time for example the payrolls or fixed assets. The auditor will then amount the pay slips of a sample of employees and the bank statements to check for any discrepancies. In the fixed assets, the auditor could go and actually verify that the fixed asset physically exists. It basically involves checking a random sample of transactions for error or fraud.

Question 2

Tests of controls are checks that are to verify the internal controls are working using different control criteria such as observation or enquiry. Substantive on the other hand are more detailed compared to tests of controls as they ascertain a given sample to be the true and correct i8n formation as stated in both the source documents and accounting reports. The main relationship between the two is that the test of control is carried out first for purposes of verification on whether the organization’s financial statements can be relied upon. In the event that the auditor is unsatisfied with the results, he shall proceed to carry out a substantive test which is a follow up test but more comprehensive. For example, an auditor may wish to determine the accuracy in a given figure say payrolls. By looking at the payroll system which is the internal system. If there are no discrepancies, the auditor will be satisfied but if there are some fall outs, the auditor will proceed to perform the substantive testing and make an assessment on the accuracy of the figures given by sourcing out all the document involved. This will help in coming up with an objective opinion once everything has been done. In the report; AIP 2014-2015, the audit was carried out over a period of 18 months. The time needs to be substantial enough to allow for effective judgement. The relationship between the two hence follows that the substantive is dependent on the tests of controls. The tests of control can be carried out solely but the substantive testing cannot. It is supposed to be a follow up of the latter and should be comprehensive enough in order to detect where the discrepancies originated from and take the necessary action suitable.

Tests of controls serve several purposes hence they are performed for the following reasons;

  1. Test a given firm’s compliance to its internal controls and ensure they are in operation.

  2. Determine the quality of the control procedures in existence within the firm.

  3. Determine the effectiveness of the control procedures existing in a firm and give an objective opinion

  4. Control risks that a firm may face by not effectively carrying out the control procedures.

Question 3

From the audit inspection report, the results are not fully consistent to some extent with the discussions above. Whereas substantive testing is meant to check for discrepancies and detect errors and fraud, there were cases of insufficient audit evidence that could support material tax deductions when the tax provision was being calculated. The source documents need to match with the account balances. In order for the tests of control to be quality, sufficient evidence needs to exist for the auditor to make an objective opinion on the financial reports. In another instance, some audit procedures deemed inadequate were performed so as to make sure improper but appropriate disclosures related to tax were revealed in the accounting financial reports. This can be termed as fraud which is totally what substantive testing is against. The auditor is supposed to be transparent and free from bias which is contrary to what was done in the above case. Tampering with the original information or adjusting to provide false information so as to fit a given standard proves that the substantive testing if conducted may yield untrue results. The auditor is supposed to exhibit a given level of professionalism when conducting the audit. In the event that the auditor cannot carry out all the activities necessary for the task, he should source out the services of other experts in the field in areas where he lacks sufficient knowledge or expertise (AIP, 2014 p.19 par 81). In the report, there are several instances where the auditors failed to use their own experts in instances where their audit team did not possess the sufficient knowledge, skills and experience needed to test and evaluate information generated by the expert. In insurance companies where auditing was undertaken, the auditor had conducted insufficient testing when carrying out a valuation of investments. This is against the tests of controls as it would confirm that the internal controls of the firm were not working. In other firms, the auditing procedure performed was not to par with the auditing standards required. This is because the policies and manuals were somewhat vague and did not provide clear application on the relevant standards on what is required of the auditors. Not specifying the required standards might interfere with test controls as a benchmark of what is expected or set is not clear enough hence the opinion given by the auditor may not be objective. In conclusion, for the audits carried out to be conclusive, adequate and effective, the tests carried out should be sufficient enough and backed up by sufficient evidence.

Reference list

Audit inspection program report for 2014–15. (2015). Australian Securities and Investments Commission (ASIC). Report 461.