Substantive testing versus control testing
Required:
For each of the test results for Gardens Nursing Home:
(a) Identify whether this is a test of controls or a substantive test of detail.
(b) Determine the key assertion addressed by the test procedure.
(c) Explain why the conclusion reached is appropriate or inappropriate.
(d) Outline the key additional procedure that you believe needs to be performed.
(a) Test 1: This is a substantive test. The test gathers evidence about the balance of trade creditors at year end and the total of purchases. In particular, the test is gathering evidence about the date the goods were received and the date the entry is posted.
Test 2: This is a test of controls. The test is gathering evidence about the process of reviewing and authorising the pricing and discount terms.
(b) Test 1: Cut-off assertion for purchases, valuation and allocation assertion for trade creditors. The dates are being verified to ensure the transactions are recorded in the correct financial period.
Test 2: Controls over pricing and discounts are relevant to the valuation and allocation assertion for trade creditors, and the accuracy assertion for purchases.
(c) Test 1: The test does not address the issue of completeness for trade creditors or fully address the cut-off assertion for purchases. The key risk for creditors is understatement. By taking a sample from the list of trade creditors the auditor is not able to detect unrecorded liabilities. The conclusion is not appropriate.
Test 2: The initial test reveals that 3 out of 20 invoices had not been authorised and incorrect discounts were recorded. The follow-up shows no pattern. The conclusion refers to the amount of the discount. This is not appropriate for a test of controls. The issue is whether the rate of deviation in the control is tolerable. If the deviation rate in the sample is tolerable when projected to the population, especially given the additional testing, then the auditor could conclude that there is no significant deviation in the control. The auditor cannot conclude the valuation of suppliers is fair based on the control tests alone.
(d) Further procedure for test 1: The auditor should examine suppliers’ invoices and goods received notes relating to the period following year-end. These documents could reveal an unrecorded liability, that is, goods recorded as received after the year-end that were actually received by the client prior to the year-end.
Further procedure for test 2: As outlined in part (c), the conclusion about the deviation in controls should be considered in light of the tolerable deviation rate. The substantive testing needs to be designed given the control risk as revealed by the control tests. Further procedures would include selecting a sample of suppliers invoices, given the control risk, and testing of pricing and discounts.