The goal of audit testing procedures in financial reporting is to gather enough relevant evidence to reasonably establish the accuracy of a financial statement.
In financial auditing, two essential techniques play a vital role in ensuring the accuracy and reliability of a financial statement: substantive testing and control testing. Let’s dive deeper into these auditing concepts and explore their unique characteristics and objectives.
Substantive Testing: Delving into the Details
In simple language, substantive testing is an auditing technique that focuses on assessing individual transactions, account balances, and disclosures in financial statements. Its primary objective is to obtain evidence about the accuracy, completeness, and validity of a financial report. A substantive testing audit involves detailed procedures, such as reviewing supporting documents, conducting analytical procedures, and performing confirmation with third parties. The goal is to identify any material misstatements, errors, or fraud that could impact the financial statement’s accuracy.
Substantive testing’s benefits lie in the ability to meticulously examine financial statements, diving deep into the nitty-gritty details. With a proverbial magnifying glass in hand, substantive testing uncovers hidden discrepancies, follows the money trail, and uncovers any irregularities that could impact the accuracy of the financial information.
Imagine being a document detective, meticulously examining every transaction, balance, and disclosure to peel back layers and uncover the truth behind the numbers. That’s the role of substantive testing. This auditing technique put its focus directly on the minute details of financial statements. By verifying the accuracy, completeness, and validity of these elements, substantive testing aims to assure the accuracy of financial information.
Examples of Substantive Testing:
- An auditor may physically examine inventory as evidence that inventory shown in the accounting records exists
- An auditor may inspect supporting documents like invoices to confirm that records of sales occurred
- An auditor may request that suppliers confirm in writing the details of the amount owing at the balance date as evidence that accounts payable is a liability
- An auditor may inquire about the collectibility of customers’ accounts as evidence that trade debtors are accurate in their valuation.
In general, the rule of thumb is that a substantive misstatement only becomes a material misstatement when it is large enough that it can be expected to influence the decisions of the users of the financial statement.
Start Getting Value With
Centraleyes for Free
See for yourself how the Centraleyes platform exceeds anything an old GRC
system does and eliminates the need for manual processes and spreadsheets
to give you immediate value and run a full risk assessment in less than 30 days
Control Testing: Safeguarding the Control Environment
Control testing is an assessment of the metaphoric fortress of internal controls. With an arsenal of questionnaires, interviews, and process walkthroughs, control testing ensures that the organization’s control mechanisms are robust and effective.
In the auditing universe, every organization needs a watchman to protect its control environment from potential risks and vulnerabilities. That’s where control testing steps in. This auditing technique assesses the design and operating effectiveness of an organization’s internal controls, which are the mechanisms in place to ensure the reliability of financial reporting, safeguard assets, and prevent fraud.
Control testing involves evaluating the controls’ design to determine whether they are appropriately implemented and addressing the most significant risks. Auditors conduct inquiries, observations, inspections, and documentation reviews to assess how effectively these controls are being followed within the organization. By identifying control weaknesses or deficiencies, control testing helps strengthen the control framework, minimizing the chances of errors, fraud, or non-compliance.
Controlled testing is also known as internal control testing. For an auditor, internal controls are as obvious and understood as anti-virus software. Let’s give some context to internal controls and define what they are.
What are Internal Controls?
Internal controls protect data as it travels through internal workflows and operations. Internal controls are tools and processes put in place to support an organization to meet its goals, complying with laws and regulations, and mitigate risk. Some internal controls will be obligatory, put in place via laws and regulations, for example, HIPAA, GLBA, FISMA, or SOX. Other internal controls will be taken on voluntarily to increase security or to meet specific risks. All companies are somewhat unique with their requirements, therefore internal controls will be relevant to your company and will be adjusted to fit your risks, likelihoods, and impacts.
Internal controls can be made up of policies, processes, and other activities that are put in place to help accomplish several security goals.
Examples of internal controls include:
- Administrative controls are the internal policies and procedures implemented to protect the security of sensitive data. It details acceptable data handling regulations and outlines the penalties for violations of such a policy.
- Technical controls cover all the tools and software used to achieve data security, including role-based access control and encryption.
- Architectural controls involve how the business as a whole handles the data on its servers as well as any data in the cloud. All devices involved in data use and transfer are included here, such as personal electronics, cloud services, and other information systems. These controls look for weak points in your network and address them appropriately.
Substantive Testing vs. Control Testing: The Key Differences
While the test of controls vs. substantive procedures is subject to debate, it is widely agreed that they both have a definitive contribution to the overall audit process. Their main differences lie in their focus and objective:
Focus: Substantive testing primarily zooms in on testing the financial statement amounts and related disclosures. It aims to obtain evidence about their accuracy, completeness, and validity. In contrast, control testing focuses on evaluating the organization’s internal controls and assessing their effectiveness in mitigating risks, preventing fraud, and ensuring compliance.
Objective: The objective of substantive testing is to identify material misstatements, errors, or fraud in financial information. It provides auditors with assurance regarding the fairness of the financial statements. On the other hand, control testing aims to provide reasonable assurance that the internal controls are operating effectively. It helps safeguard the reliability of financial reporting, asset protection, and compliance with regulations.
The Dynamic Duo: When Powers Combine
While substantive audit procedures vs. tests of controls have distinct capabilities, their true strength lies in collaboration. Together, they work to ensure the accuracy and reliability of financial statements. Substantive testing uncovers the truth behind the numbers, while Control Testing ensures the controls are in place to prevent errors and fraud. It’s a match made in auditing heaven!
Auditors must choose the right approach for each auditing engagement. Substantive testing may be ideal when there are higher risks or when there’s a need for detailed verification. Control testing, on the other hand, shines when evaluating internal controls and identifying weaknesses in the control environment. The key is to strike the right balance between these two auditing powerhouses.
Conclusion
By combining both substantive testing and control testing in the audit process, auditors can gain a comprehensive understanding of the organization’s financial integrity and control environment. These auditing techniques work hand in hand, ensuring that the financial information is accurate, reliable, and protected from potential risks and vulnerabilities.
Start Getting Value With
Centraleyes for Free
See for yourself how the Centraleyes platform exceeds anything an old GRC
system does and eliminates the need for manual processes and spreadsheets
to give you immediate value and run a full risk assessment in less than 30 days
