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Substantive analytical procedures Vs. tests of detail

Auditing: Substantive analytical procedures versus Substantive tests of detail

It can be difficult for students who don’t have auditing experience to make sense of the differences between substantive analytical procedures and tests of detail. I like to give my KnowledgEquity students plenty of examples and questions to understand and apply concepts, such as the following example.

Example:
Entity A has rent expense of 12,500 in it’s income statement. There are two ways the auditor can get comfort over this account.

  1. First, the auditor could test using a test of detail and inspect every single rent invoice for every month. This is a long and ineffective process.
  2. The second option is for the auditor to perform a substantive analytical procedure whereby a reasonableness test is performed. That is, a prediction of what the amount should be and a comparison against the actual with subsequent follow up for major fluctuations. This is likely to be much more efficient than a test of detail.

 

To perform a substantive analytical procedure, the auditor would select the first month and agree this to the rent invoice or lease contract to agree that the monthly rent is say $1,000. Then the auditor would predict that the rent for the full year should be 12,000 (1,000 x 12 months).

The actual balance would then be compared to the predicted amount which would indicate a difference of $500. The auditor would then be required to investigate this variance of $500. If management explains that it was for hiring out an extra room for a conference, the auditor would need to inspect corroborating evidence to support this explanation. Once done, the rent amount has been audited even though only one month was actually tested.

There are advantages and disadvantages of substantive analytical procedures and tests of detail which are summarised as follows:

Substantive analytical procedures

  • Indirect evidence based on relationships (less reliable then TOD. Cannot be performed alone when risks are significant)
  • Not time consuming (less effort involved, less costs due to less time)
  • Identifies only general unusual fluctuations which would then require further investigation

Substantive tests of detail

  • Obtains direct evidence for a sample (thus more reliance placed on this. Required to be performed when risks are  assessed as significant)
  • Time consuming (a lot of effort. Higher costs for the client)
  • Identifies specific errors or misstatements

Theashen Vandiar with nameIn KnowledgEquity’s Advanced Audit and Assurance Support for your CPA course, there are short explanatory videos, practice exams, module quizzes, webinars and flowcharts to help you embed your knowledge and be able to understand the AAA subject. These are available as part of our Advanced Audit and Assurance support courses. Once you have concepts like these embedded in your knowledge data bank, you are well on the way to understanding the audit role.

Theashen Vandiar

March 14, 2017

2 responses on "Substantive analytical procedures Vs. tests of detail"

  1. Thank you Theashan this is a nice easy and logical example of the difference between substantive analytical procedures vs Test of Detail, the example of rent is consistent and predictable.

  2. Thanks for clarifying the two.

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