Substantive procedures definition
/What are Substantive Procedures?
Substantive procedures are intended to create evidence that an auditor assembles to support the assertion that there are no material misstatements in regard to the completeness, validity, and accuracy of the financial records of an entity. Thus, substantive procedures are performed by an auditor to detect whether there are any material misstatements in accounting transactions. Substantive procedures include the following general categories of activity:
Testing classes of transactions, account balances, and disclosures
Agreeing the financial statements and accompanying notes to the underlying accounting records
Examining material journal entries and other adjustments made during the preparation of the financial statements
At a general level, substantive procedures related to testing transactions can include the following:
Examining documentation indicating that a procedure was performed
Reperforming a procedure to ensure that the procedure functions as planned
Inquiring or observing regarding a transaction
Why Substantive Procedures are Important
Auditing involves many activities, but the core activity is substantive procedures. Conducting these procedures places a heavy emphasis on the manner in which auditors justify their assertions regarding the state of a client’s accounting records and the financial statements derived from them. In general, when an auditor perceives a client to have a higher degree of risk of including materially incorrect information in its financial statements, it will be necessary to conduct more in-depth substantive procedures.
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Examples of Substantive Procedures
Examples of substantive procedures are noted below:
Bank confirmation
Inquire of management regarding the collectability of customer accounts
Match customer orders to invoices billed
Match collected funds to invoices billed
Observe a physical inventory count. The intent is to verify that the client is correctly counting and valuing all inventory, while also verifying that the client actually owns all of the inventory being counted.
Confirm inventories not on-site
Match purchasing records to inventory on hand or sold
Confirm the calculations on an inventory valuation report
Observe fixed assets
Match purchase orders and supplier invoices to fixed asset records
Confirm accounts payable
Examine accounts payable supporting documents
Confirm debt
Analytical analysis of assets, liabilities, revenue, and expenses
Thus, an auditor who is testing a validity assertion regarding a company's fixed assets could conduct a physical observation of the assets, and then test for record accuracy by evaluating whether there is an asset impairment.
Substantive procedures are included in the audit plan around which an audit is structured. If the results of substantive procedures are not as expected, additional procedures may be added to the audit plan.