Lesson 21

SUBSTANTIVE PROCEDURES

Auditing
Auditor’s Opinion (depends upon)
Reasonable Assurance (depends upon)

Sufficient Appropriate Audit evidence
      (depends upon)

Audit procedures 
» Test of Control
» Substantive Procedures 

Test of Control
The auditor is required to perform tests of controls:  
• Test of details
• Analytical procedures 
• When
the internal controls are operating effectively or 
• When substantive procedures alone do not provide sufficient appropriate audit evidence at the 
assertion level.
Tests of controls comprise of testing three things: 
1. Design – that the internal controls are properly designed to cover the risk it is meant for.
2. Implementation – that the internal controls have been put into operation.
3. Operating effectiveness – that the systems of internal control were operating effectively at 
relevant times during the period.

How to perform test of control 
• Testing the Design: 
– Proper design of internal control is tested through ICQs and ICEC.
• Testing the Implementation: 
– Implementation of internal control is tested through walk through test with a little sample
size. 
• Testing the Operating effectiveness:
– Here the test is performed through a compliance test based on a judgmental sample. 


Substantive Procedures
Substantive procedures are performed in order to detect material misstatements at the assertion level (like;
occurrence, completeness, accuracy, valuation, existence, rights and control), and include tests of details of 
classes of transactions, account balances and disclosures and substantive analytical procedures. 
The auditor plans and performs substantive procedures to be responsive to the related assessment of the
risk of material misstatement.
Irrespective of the assessment of risk of material misstatement, the auditor should design and perform
substantive procedures for each material class of transactions, account balance, and disclosure. 

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The auditor’s substantive procedures should include the following audit procedures related to the financial
statement closing process: 
• Agreeing the financial statements to the underlying accounting records; and
• Examining material journal entries and other adjustments made during the course of preparing 
the financial statements.
When the auditor has determined that an assessed risk of material misstatement at the assertion level is a
significant risk, the auditor should perform substantive procedures that are specifically responsive to that
risk.

Types of Substantive Procedures 
• Test of details
– Land   Registry
– Debtors   Circular
– Building rent  Deed/Agreement 

• Analytical procedures 
– Payroll   Turnover ratio
     Comparing with previous    
     month’s salary 
– Production Cost  Comparing with the number of    
   units produced 
     Comparing with the previous month’s   
     cost of production

Nature of Substantive Procedures
Substantive analytical procedures are applied on large volume of transactions, which are predictable over
time.  
• Tests of details are ordinarily more appropriate to obtain audit evidence regarding certain assertions
about account balances, including existence and valuation. 
• Analytical procedures are applied on large volume of transactions, which are predictable over time.
(cost of goods sold, payroll, sale) 
In designing substantive analytical procedures, the auditor considers such matters as the following:
• The suitability
 of using analytical procedures given the assertions. 
If controls, over sales order processing, are weak; the auditor may place more reliance on tests of details
rather than substantive analytical procedures for assertions related to debtors.
When auditing the collectibility of accounts receivable, the auditor may apply substantive analytical
procedures to an aging of customers’ accounts in addition to tests of details on subsequent cash receipts. 
• The reliability
 of the data; 
In determining whether data is reliable for purposes of designing substantive analytical procedures, the
auditor considers the following: 
o Information is ordinarily more reliable when it is obtained from independent sources outside the
entity 
o Comparability of the information available
o Nature and relevance of the information available (whether budgets have been established as 
results to be expected rather than as goals to be achieved.
o Controls over the preparation of the information (controls over the preparation, review and 
maintenance of budgets)
• Whether the expectation is sufficiently precise
 to identify a material misstatement at the desired level of 
assurance. 
 For this the auditor considers the following facts:
i. The accuracy with which the expected results of substantive analytical procedures can be 
predicted (comparison of GP ratio should be consistent rather than the ratio of discretionary
expenses like entertainment) 

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ii. The degree to which information can be disaggregated (effective analysis will be of a component
not of the entity as a whole) 
iii. The availability of the information, both financial and non financial (budgets are financial,
whereas units of production are non financial)  
• The amount of any difference in recorded amounts
 from expected values that is acceptable.
Depends upon the:  
i. materiality
ii. Possibility of misstatement in the specific account balance, class of transactions, or disclosure  

Timing of Substantive Procedures

YEAR END SUBSTANTIVE PROCEDURES ARE ALWAYS MORE RELIABLE

When substantive procedures are performed at an interim date, the auditor should perform further
substantive procedures or substantive procedures combined with tests of controls to cover the remaining
period that provide a reasonable basis for extending the audit conclusions from the interim date to the
period end.
In considering whether to perform substantive procedures at an interim date the auditor considers such
factors as the following: 
• The control environment and other relevant controls. (Like payroll disbursement)
• The availability of information at a later date that is necessary for the auditor’s procedures (prov for 
doubtful debts can be investigated interim but debtor and inventory can be verified at the year end).
• The objective of the substantive procedure.
• The assessed risk of material misstatement (prefer always at year end).
• The nature of the class of transactions or account balance and related assertions (like frequency of 
occurrence of the transactions e.g. salaries are paid monthly whereas bonuses are paid annually).
• The ability of the auditor to perform appropriate substantive procedures or substantive procedures 
combined with tests of controls to cover the remaining period in order to reduce the risk that
misstatements that exist at period end are not detected (staffing problem that cannot make the
auditor able to extend till the year end) 
If substantive procedures are performed at an interim date, the auditor may sometimes consider applying
tests of controls also on the transactions of remaining period while extending his substantive procedures
from interim date to the period end.
In situations of actual or expected fraud, auditor may prefer applying substantive procedures at period end.
If misstatements are detected in classes of transactions or account balances at an interim date, the auditor
ordinarily modifies the related assessment of risk and the planned nature, timing or extent of the substantive
procedures covering the remaining period.
Substantive procedures applied in a prior period are not sufficient to address a risk of material misstatement
in the current year except in certain circumstances. 

Extent of performance of substantive procedures
Greater the risk of material misstatement due to weaknesses in the system of internal control, the greater
would be the risk of material misstatement in the financial statements.
In designing tests of details, the auditor may use either audit sampling or may choose to select items to be
tested by some other selective means of testing.

Adequacy of Presentation and Disclosure
The auditor should perform audit procedures to evaluate whether the overall presentation of the financial
statements, including the related disclosures, are in accordance with the applicable financial reporting
framework. 

Assertions in obtaining Audit Evidence
(a) Assertions about classes of transactions
 and events for the period under audit; 
i. Occurrence – transactions and events that have been recorded have occurred and pertain
to the entity; 

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ii. Completeness – all transactions and events that should have been recorded have been
recorded; 
iii. Accuracy – amounts and other data relating to recorded transactions and events have been
recorded appropriately. 
iv. Cutoff – transactions and events have been recorded in the proper period.
v. Classification – transactions and events have been recorded in the proper accounts. 
(b) Assertions about account balances
 at the period end.
i. Existence – assets, liabilities, and equity interests exist;
ii. Rights and obligations – the entity holds or controls the rights to assets, and liabilities are 
the obligations of the entity;
iii. Completeness – all assets, liabilities and equity interests that should have been recorded 
have been recorded;
iv. Valuation and allocation – assets, liabilities, and equity interests are included in the financial 
statements at appropriate amounts and any resulting valuation or allocation adjustments
are appropriately recorded. 
(c) Assertions about presentation and disclosure
:
i. Occurrence and rights and obligations – disclosed events, transactions and other matters 
have occurred and pertain to the entity;
ii. Completeness – all disclosures that should have been included in the financial statements 
have been included;
iii. Classification and understandability – financial information is appropriately presented and 
described, and disclosures are clearly expressed;
iv. Accuracy and valuation – financial and other information are disclosed fairly and at 
appropriate amounts.

Audit Procedures for obtaining Audit Evidence
The auditor uses one or more types of audit procedures described below:
(i) Inspection of Records or Documents

It consists of examining records or documents whether internal or external, in paper form, electronic form,
or other media. Inspection provides evidence of varying degrees of reliability depending on their nature and
source and in the case of internal records, on effectiveness of controls over their production.
(ii) Inspection of Tangible Assets

It consists of physical examination of the assets. It may provide reliable audit evidence of their existence
cannot necessarily about other assertions.
(iii) Inquiry

It means seeking information of knowledgeable persons throughout the entity or outside the entity. Those
may be formal written or informal oral. It provides an auditor with new information or corroborative
evidences. It may also bring to high information different from the one possessed by the auditor. Certain
oral inquiries might be got confirmed through written representations. 
(iv) Confirmations

It is a specific type of inquiry. It is the process of obtaining a representation of information or an existing
condition directly from a third party. Confirmations are sought from debtors, creditors, bankers, legal
advisors etc. 

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Lesson 22

AUDIT EVIDENCE

Auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on
which to base the audit opinion.

Concept of Audit Evidence
Audit evidence is all the information used by the auditor in arriving at the conclusions on which his opinion
is based and includes the information contained in the accounting records underlying the financial
statements and other information. It is obtained from audit procedures performed during the course of
audit and may include audit evidence obtained from other sources such as pervious audits and a firm’s
quality control procedures for client acceptance and continuance.
Accounting records generally include the records of initial entries and supporting records, such as checks
and records of electronic fund transfers; invoices; contracts; the general and subsidiary ledgers, journal
entries and other adjustments to the financial statements that are not reflected in formal cost allocations,
computations, reconciliations and disclosures. The entries in the accounting records are often initiated,
recorded, processed and reported in the electronic form. In addition, the accounting records may be part of
integrated systems that share data and support all aspects of the entity’s financial reporting, operations and
compliance objectives.
Auditor obtains most of the audit evidence from accounting records of the entity. If accounting records do
not provide sufficient audit evidence, the auditor obtains other audit evidence.
Other information that the auditor may use as audit evidence includes: 
• minutes of meetings; 
• confirmations from third parties, 
• analysis’ reports; 
• comparable data about competitors (benchmarking); 
• controls manuals;
• information obtained by the auditor from such audit procedures as inquiry, observation; and 
inspection; 
• and other information developed by, or available to, the auditor that permits the auditor to reach 
conclusions through valid reasoning. 

Sufficient appropriate Audit Evidence
Sufficiency:  The measure of quantity of audit evidence.
Appropriateness: The measure of quality i.e. relevance and reliability in providing support of
detecting misstatements in account balance classes of transactions and disclosures and relevant assertions.

The quantity of audit evidence needed is affected by: 
- the risk of misstatement (the greater the risk, the more audit evidence is likely to be required); and
- the quality of such audit evidence (the higher the quality, the less may be required). 
Accordingly sufficiency and appropriateness are interrelated.  However, merely obtaining more audit
evidence may not compensate for its poor quality.
Audit evidence obtained through same audit procedures may be relevant to certain assertions but not
relevant to other assertions.
The auditor often obtains evidence about an assertion from different sources or of different nature.
Evidence about an assertion is not a substitute for evidence regarding another assertion.

Sources of obtaining Audit Evidence 
i) Internal source - through accounting system, management, employees, underlying documentation
etc. 
ii) External source - third parties, i.e. suppliers, customers bankers legal advisers and other parties
who have knowledge of the enterprise. 


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Nature of Audit Evidence
 i)  Visual
 ii) Oral
 iii) Documentary

Reliability of Audit Evidence - Generalizations
Following generalizations are considered useful in assessing the reliability of audit evidence (subject to
certain important exceptions):
 i) Audit evidence obtained from independent sources outside the entity is more reliable.
 ii) Evidence generated internally is more reliable when related controls are effective.
 iii) Evidence obtained by an auditor directly is more reliable than that obtained indirectly or by
interference e.g. Bank balance confirmation certificate received by an auditor is more reliable than the bank
statement obtained from the management or observation of a control rather than making inquiry about the
application of a control. 
iv) Written evidence is more reliable than oral representation.
v) Audit evidence provided by original documents is more reliable than that provided by 
photocopies and facsimiles.

Other factors relating to Audit Evidence 
i) Information on which audit procedures are based should be sufficiently accurate and
complete. Therefore, auditor should also test the system for generating such information
while using it for his procedures. 
ii) Auditor’s reliance increases when audit evidence obtained from one source is consistent
with another source; if it is inconsistent further procedures may be performed. 
iii) Cost of obtaining the audit evidence is also considered when obtaining it.
iv) While forming an audit opinion, the auditor does not have to examine all the items or 
obtain all the evidences which might be available. He can reach a conclusion by examining
a sample of such transactions. He also relies on persuasive evidences. However, if evidence
is less than persuasive, he does not consider it reliable. 

Assertions in obtaining Audit Evidence
 (a) Assertions about classes of transactions and events for the period under audit; 
(i) Occurrence – transactions and events that have been recorded have occurred and
pertain to the entity; 
(ii) Completeness – all transactions and events that should have been recorded have
been recorded; 
(iii) Accuracy – amounts and other data relating to recorded transactions and events
have been recorded appropriately. 
(iv) Cutoff – transactions and events have been recorded in the proper period. 
(v) Classification – transactions and events have been recorded in the proper
accounts. 
 (b) Assertions about account balances at the period end.
(i) Existence – assets, liabilities, and equity interests exist;
(ii) Rights and obligations – the entity holds or controls the rights to assets, and 
liabilities are the obligations of the entity;
(iii) Completeness – all assets, liabilities and equity interests that should have been 
recorded have been recorded;
(iv) Valuation and allocation – assets, liabilities, and equity interests are included in the 
financial statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded. 
 (c) Assertions about presentation and disclosure:
(i) Occurrence and rights and obligations – disclosed events, transactions and other 
matters have occurred and pertain to the entity;
(ii) Completeness – all disclosures that should have been included in the financial 
statements have been included; 

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(iii) Classification and understandability – financial information is appropriately
presented and described, and disclosures are clearly expressed; 
(iv) Accuracy and valuation – financial and other information are disclosed fairly and
at appropriate amounts. 

Audit procedures for obtaining audit evidence
Auditor performs audit procedures to obtain an understanding of the entity, its environment and to assess
risks of material misstatement. Procedures are also applied to test operating effectiveness of internal
controls and for detection of material misstatements at assertion level.
The auditor always performs risk assessment procedures to provide a satisfactory basis for assessment of
risks at financial statement level. In addition to these risk assessment procedures, which alone are not
sufficient, the auditor performs audit procedures in the form of tests of control and substantive procedures.
Tests of controls are applied when auditor expects to rely on operating controls. Through tests of controls,
he tests the controls to support the risk assessment. These are also applied when substantive procedures
alone do not provide sufficient appropriate audit evidence.
Nature and timing of audit procedures may be affected by the entity’s data retention policies or their
practice to convert source documents into computer images through scanning, means of communication
being used by the entity e.g. electronic messaging rather than written purchase orders.
The auditor uses one or more types of audit procedures described below:
(i) Inspection of Records or Documents

 It consists of examining records or documents whether internal or external, in paper form,
 electronic form, or other media. Inspection provides evidence of varying degrees of reliability
 depending on their nature and source and in the case of internal records, on effectiveness of
 controls over their production.
(ii) Inspection of Tangible Assets
  
 It consists of physical examination of the assets. It may provide reliable audit evidence of their
 existence cannot necessarily about other assertions.
(iii) Inquiry

 It means seeking information of knowledgeable persons throughout the entity or outside the entity.
 Those may be formal written or informal oral. It provides an auditor with new information or
 corroborative evidences. It may also bring to high information different from the one possessed by
 the auditor. Certain oral inquiries might be got confirmed through written representations.
(iv) Confirmations

 It is a specific type of inquiry. It is the process of obtaining a representation of information or an
 existing condition directly from a third party. Confirmations are sought from debtors, creditors,
 bankers, legal advisors etc.
(v) Recalculation

 It consists of checking the mathematical accuracy of documents or records. It can be performed
 through use of information technology. 
(vi) Re-performance
   
 It is the auditor’s independent execution of procedures or controls that were originally performed
 as part of the entity’s internal control, either manually or through the use of CAATs, for example,
 re-performing the aging of accounts receivable.
(vii) Analytical procedures

 It consists of evaluations of financial information made by a study of plausible relationship among
 both financial and non-financial data. It includes investigation of significant fluctuations found and
 the relationship that are inconsistent. 

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Lesson 23

SUFFICIENT APPROPRIATE AUDIT EVIDENCE
AND 
TESTING THE SALES SYSTEM

Recap:
Audit evidence includes: the information contained in the accounting records underlying the financial
statements. 
Audit evidence might include: 
• Documents (invoices, credit notes, cash receipts)
• Accounting entries (write down to NRV, depreciation)
• Answers from the management (Provisions)
• Information from third parties (banks, debtors)
• Computations (depreciation, accruals, provisions)
• Observations (inventory count) 

Sufficiency:  The measure of quantity of audit evidence.
Appropriateness: The measure of quality i.e. relevance
 and reliability of audit evidence.
Key questions for the auditor to consider therefore will be: 
1. Do I have enough evidence to reach a conclusion on this audit area?
2. Is the evidence that I have, reliable enough to, allow me to reach a conclusion on this area of the 
audit?

Assertions in obtaining Audit Evidence
(a) Assertions about classes of transactions
 and events for the period under audit; 
i. Occurrence – transactions and events that have been recorded have occurred and pertain
to the entity; 
ii. Completeness – all transactions and events that should have been recorded have been
recorded (accruals & depreciation); 
iii. Accuracy – amounts and other data relating to recorded transactions and events have been
recorded appropriately. (valuation and estimations) 
iv. Cutoff – transactions and events have been recorded in the proper period.
v. Classification – transactions and events have been recorded in the proper accounts. 
(b) Assertions about account balances
 at the period end.
i. Existence – assets, liabilities, and equity interests exist;
ii. Rights and obligations – the entity holds or controls the rights to assets, and liabilities are 
the obligations of the entity;
iii. Completeness – all assets, liabilities and equity interests that should have been recorded 
have been recorded;
iv. Valuation and allocation – assets, liabilities, and equity interests are included in the financial 
statements at appropriate amounts and any resulting valuation or allocation adjustments
are appropriately recorded. 
(c) Assertions about presentation and disclosure
:
i. Occurrence and rights and obligations – disclosed events, transactions and other matters 
have occurred and pertain to the entity;
ii. Completeness – all disclosures that should have been included in the financial statements 
have been included;
iii. Classification and understandability – financial information is appropriately presented and 
described, and disclosures are clearly expressed; 
iv. Accuracy and valuation – financial and other information are disclosed fairly and at
appropriate amounts. 

Audit procedures for obtaining Audit Evidence
The auditor uses one or more types of audit procedures described below: 

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(i) Inspection of Records or Documents
 It consists of examining records or documents whether internal or external, in paper form,
 electronic form, or other media. Inspection provides evidence of varying degrees of reliability
 depending on their nature and source and in the case of internal records, on effectiveness of
 controls over their production.
(ii) Inspection of Tangible Assets
  
 It consists of physical examination of the assets. It may provide reliable audit evidence of their
 existence cannot necessarily about other assertions.
(iii) Inquiry

 It means seeking information of knowledgeable persons throughout the entity or outside the entity.
 Those may be formal written or informal oral. It provides an auditor with new information or
 corroborative evidences. It may also bring to high information different from the one possessed by
 the auditor. Certain oral inquiries might be got confirmed through written representations.
(iv) Confirmations

 It is a specific type of inquiry. It is the process of obtaining a representation of information or an
 existing condition directly from a third party. Confirmations are sought from debtors, creditors,
 bankers, legal advisors etc.
(v) Recalculation

 It consists of checking the mathematical accuracy of documents or records. It can be performed
 through use of information technology.
(vi) Re-performance
  
 It is the auditor’s independent execution of procedures or controls that were originally performed
 as part of the entity’s internal control, either manually or through the use of CAATs, for example,
 reperforming the aging of accounts receivable.
(vii) Analytical procedures

 It consists of evaluations of financial information made by a study of plausible relationship among
 both financial and non-financial data. It includes investigation of significant fluctuations found and
 the relationship that are inconsistent.

TESTING THE SALES SYSTEM
Control Objectives
For many businesses, sales are made on credit and so objectives for the sales cycle includes control debtors
as well. 
These control objectives include: 
a) Customers' orders should be authorized, controlled and recorded in order to execute them
promptly 
b) Goods shipped and work completed should be controlled to ensure that invoices are issued and
revenue recorded for all sales.  
c) Goods returned and claims by customers (for example, in respect of damaged goods) should be 
controlled in order to determine the liability for goods returned and claims received. . 
d) Invoices and credits should be appropriately checked for accuracy and should be authorized before
being entered in the receivables' records.  
e) Authorized customer transactions, and only those transactions, should be accurately entered in the
accounting records.  
f) There should be procedures to ensure that sales invoices are subsequently paid by customers and
that doubtful amounts are identified in order to determine any provisions or write offs required  

Control procedures over sales and debtors
There are a large number of controls that may be required in the sales cycle due to the importance of this
area in any business and the possible opportunities that exist for diverting sales and cash receipts away from 
the business.
 Typical control procedures at key stages of the sales cycle are: 
1. Orders
2. Dispatch
3. Invoicing and credit notes 

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4. Returns inwards
5. Receivables
6. Bad Debts

(a) Orders
(i) Existing customers should be allocated a credit limit and it should be ascertained whether this limit 
is to be exceeded if the new order is accepted. If so the matter should be referred to credit control.
(ii) Any new customer should be referred to the credit control department before the order is accepted. 
(iii) All orders received should be recorded on pre-numbered sales order documents so that a check can
be made that all orders have been dealt with -a completeness check. 
(iv) All orders should be authorized before any goods are dispatched.
(v) The sales order document should be used to produce a dispatch note for the goods outwards 
department. No goods may be dispatched without a dispatch note.

(b) Dispatch 
(i) Dispatch notes should be pre-numbered and a register kept of them to enable them to be matched
with relate to sales invoices and customer orders. 
(ii) Dispatch notes should be authorized before goods leave the company.
(iii) Regular checks should be made to ensure that all dispatches have been invoiced. 

(c) Invoicing and Credit Notes 
(i) Sales invoices should be authorized by a responsible official and matched with the authorized order
and dispatch note. 
(ii) All invoices and credit notes should be entered In daybook records, the sales ledger, and sales
ledger control account. Batch totals should be maintained for this purpose. 
(iii) Sales invoices and credit notes should be checked for prices. casts and calculations by a person
other than the one preparing the invoice. 
(iv) All invoices and credit notes should be serially pre-numbered and regular sequence checks should
be carried out. 
(v) Credit notes should be authorized by someone unconnected with dispatch or sales ledger functions.
(vi) Copies of cancelled invoices should be retained. 
(vii) Any cancellation of an invoice should lead to a cancellation of the related dispatch note.
(viii) Cancelled (and free of charge) invoices should be signed by a responsible official. 
(ix) Each invoice should distinguish between different types of sales and, if relevant, different rates of
VAT or sales tax. Any coding of invoices should be periodically checked independently 

(d) Returns 
(i) Any goods returned by the customer should be checked for obvious damage and, when accepted. a
document should be raised. 
(ii) All goods returned should be used to prepare appropriate credit notes 

(e) Receivables/Debtors 
(i) A receivables ledger control account should be prepared regularly and checked to individual sales
ledger balances by an Independent official. 
(ii) Receivables ledger personnel should be independent of dispatch and cash receipt functions.
(iii) Statements should be sent regularly to customers.
(iv) Formal procedures should exist for following up overdue debts which should be highlighted either 
by the preparation of an aged list of balances or by the preparation of regular customer statements.
(v) Letters should be sent to customers for collection of overdue debts. A policy should be in place for 
the Institution of legal proceeds where appropriate. 

f) Bad debts 
(i) The authority to write off a bad debt should be in writing. Appropriate adjustments should be
made to the sales ledger and the control account 

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(ii) The use of court action or the writing-off of a bad debt should be authorised by an official
independent of the cash receipt function. 

Tests of Control
Tests of control should be designed to check that the control procedures are being applied and that
objectives are being achieved. Tests may be appropriate under the following broad headings. 
(a) Carry out sequence test checks on invoices, credit notes, dispatch notes and orders. Ensure that all
items are included and that there are no omissions or duplications. 
(b) Check the existence of evidence for authorization in respect of:
i. acceptance of the order (the creditworthiness check)
ii. dispatch of goods  
iii. raising of the invoice or credit note 
iv. pricing and discounts
v. write-off of bad debts. 
Check both that the relevant signature exists and that the control has been applied.
(c) Seek evidence of checking of the arithmetical accuracy of:  
i. invoices, including pricing, and VAT and sales tax calculations 
ii. credit notes, 
This is often done by means of a 'grid stamp' containing several signatures on the face of the document.
Ensure that the control has been applied by checking the accuracy of such invoices and credit notes. 
(d) Check dispatch notes and goods returned notes to ensure that they are matched with invoices and
credit notes. 
(e) Check that control account reconciliations have been performed and reviewed.
In all cases, tests should be performed on a sample basis. 

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Lesson 24

TESTING THE SALES SYSTEM

Control Objectives
For many businesses, sales are made on credit and so objectives for the sales cycle includes control debtors
as well. 
These control objectives include: 
a) Customers' orders should be authorized, controlled and recorded in order to execute them
promptly 
b) Goods shipped and work completed should be controlled to ensure that invoices are issued and
revenue recorded for all sales.  
c) Goods returned and claims by customers (for example, in respect of damaged goods) should be
controlled in order to determine the liability for goods returned and claims received. . 
d) Invoices and credits should be appropriately checked for accuracy and should be authorized before
being entered in the receivables' records.  
e) Authorized customer transactions, and only those transactions, should be accurately entered in the
accounting records.  
f) There should be procedures to ensure that sales invoices are subsequently paid by customers and
that doubtful amounts are identified in order to determine any provisions or write offs required  

Control Procedures over Sales and Debtors
There are a large number of controls that may be required in the sales cycle due to the importance of this
area in any business and the possible opportunities that exist for diverting sales and cash receipts away from
the business.
Typical control procedures at key stages of the sales cycle are: 
1. Orders
2. Dispatch
3. Invoicing and credit notes
4. Returns inwards
5. Receivables
6. Bad Debts 

(a) Orders 
(i) Existing customers should be allocated a credit limit and it should be ascertained whether this limit
is to be exceeded if the new order is accepted. If so the matter should be referred to credit control. 
(ii) Any new customer should be referred to the credit control department before the order is accepted.
(iii) All orders received should be recorded on pre-numbered sales order documents so that a check can 
be made that all orders have been dealt with -a completeness check. 
(iv) All orders should be authorized before any goods are dispatched.
(v) The sales order document should be used to produce a dispatch note for the goods outwards 
department. No goods may be dispatched without a dispatch note.

(c) Dispatch 

(i) Dispatch notes should be pre-numbered and a register kept of them to enable them to be matched
with relate to sales invoices and customer orders. 
(ii) Dispatch notes should be authorized before goods leave the company.
(iii) Regular checks should be made to ensure that all dispatches have been invoiced. 
(d) Invoicing and credit notes
(i) Sales invoices should be authorized by a responsible official and matched with the authorized order 
and dispatch note.
(ii) All invoices and credit notes should be entered In daybook records, the sales ledger, and sales 
ledger control account. Batch totals should be maintained for this purpose. 

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(iii) Sales invoices and credit notes should be checked for prices. casts and calculations by a person
other than the one preparing the invoice. 
(iv) All invoices and credit notes should be serially pre-numbered and regular sequence checks should
be carried out. 
(v) Credit notes should be authorized by someone unconnected with dispatch or sales ledger functions.
(vi) Copies of cancelled invoices should be retained. 
(vii) Any cancellation of an invoice should lead to a cancellation of the related dispatch note.
(viii) Cancelled (and free of charge) invoices should be signed by a responsible official. 
(ix) Each invoice should distinguish between different types of sales and, if relevant, different rates of
VAT or sales tax. Any coding of invoices should be periodically checked independently 

(e) Returns 
(i) Any goods returned by the customer should be checked for obvious damage and, when accepted. a
document should be raised. 
(ii) All goods returned should be used to prepare appropriate credit notes 

(f) Receivables/Debtors 
(i) A receivables ledger control account should be prepared regularly and checked to individual sales
ledger balances by an Independent official. 
(ii) Receivables ledger personnel should be independent of dispatch and cash receipt functions.
(iii) Statements should be sent regularly to customers.
(iv) Formal procedures should exist for following up overdue debts which should be highlighted either 
by the preparation of an aged list of balances or by the preparation of regular customer statements.
(v) Letters should be sent to customers for collection of overdue debts. A policy should be in place for 
the Institution of legal proceeds where appropriate.

g) Bad debts 
(i) The authority to write off a bad debt should be in writing. Appropriate adjustments should be
made to the sales ledger and the control account 
(ii) The use of court action or the writing-off of a bad debt should be authorized by an official
independent of the cash receipt function. 

Tests of Control
Tests of control should be designed to check that the control procedures are being applied and that
objectives are being achieved. Tests may be appropriate under the following broad headings. 
(a) Carry out sequence test checks on invoices, credit notes, dispatch notes and orders. Ensure that all
items are included and that there are no omissions or duplications. 
(b) Check the existence of evidence for authorization in respect of:
iii. acceptance of the order (the creditworthiness check) 
iv. dispatch of goods 
v.
raising of the invoice or credit note 
vi. pricing and discounts 
vii. Write off debtors as bad debts.
Check both that the relevant signature exists and that the control has been applied. 
(c) Seek evidence of checking of the arithmetical accuracy of: 
viii. invoices, including pricing, and VAT and sales tax calculations  
ix. credit notes,
This is often done by means of a 'grid stamp' containing several signatures on the face of the document.
Ensure that the control has been applied by checking the accuracy of such invoices and credit notes. 
(d) Check dispatch notes and goods returned notes to ensure that they are matched with invoices and 
credit notes.
(e) Check that control account reconciliations have been performed and reviewed. 
In all cases, tests should be performed on a sample basis.


90
  
Lesson 25

TESTING THE PURCHASES SYSTEM

Control Objectives
Purchases are often made on credit and so the purchases cycle includes payables. You also need to bear in
mind that 'purchases' has a wide meaning in terms of the purchases cycle as purchases will include not only
inventory items but also all types of expense and the purchase of non current assets.
The control objectives are as follows. To ensure that: 
e) Purchased goods/services are ordered under proper authority and using proper procedures
f) Purchased goods/services are only ordered as necessary for the proper conduct of the business 
operations and are ordered from suitable, approved suppliers
g) Goods/services received are inspected for quality, quantity and description
h) Invoices and related documentation are properly checked and approved as being valid before 
being entered as trade creditors
i) All valid transactions relating to payables (suppliers' invoices, credit notes and adjustments), and 
only those transactions, should be accurately recorded in the accounting records.

Control Procedures over Purchases and Payables
As with the sales system, there are a large number of controls that may be required in the purchases cycle
due to the importance of this area in any business and once again, the following list is classified by type of
control.
(a)      Orders 
(i) Requisition notes for purchases should be authorized.
(ii) All orders should be authorized by a responsible official whose authority limits should 
be pre-defined.
(iii) Major items e.g. capital expenditure, should be authorized at an appropriate level, 
possibly by the Board of Directors
(iv) All orders should be recorded on official documents showing suppliers' names, 
quantities ordered and price.
(v) Copies of orders should be retained as a method of following up late deliveries by 
suppliers.
(vi) Re-order levels and quantities should be pre-set and preferably recorded in advance on 
the requisition note.
(b)     Receipt of goods 
(i) Goods inwards areas should be identified to deal with the receipt of all goods.
(ii) All goods should be checked for quantity, quality and description. Goods received 
notes should be raised for all goods accepted. The GRN should be signed by a
responsible official. 
(iii) GRNs should be checked against purchase orders and procedures should exist to 
notify the supplier of under or over-deliveries. GRNs should be sequentially
numbered and checked periodically for completeness. 

(c)      Invoicing and returns 
(i) Purchase invoices received should be stamped with an approval grid and given a
unique serial number to ensure purchase invoices do not go astray. 
(ii) Purchase invoices should be matched with goods received notes and company orders
and should not be processed until this is done. 
(iii) The invoice should be checked against the order and the GRN, and casts and
extensions should also be checked. 
(iv) The invoices should be signed as approved for payment by a responsible official
independent of the ordering and receipt of goods functions. 
(v) Invoice sequential numbers should be checked against purchase day book details.
(vi) Input VAT should be recorded separately from the expense element of the invoice 
total. 

91
  
(vii) Invoices should be properly allocated to the nominal ledger accounts, perhaps by
allocating expenditure codes. A portion of such coding should be checked
independently. 
(viii) Batch controls should be maintained over the posting of invoices to the purchases day
book, nominal ledger and purchase ledger. 
(ix) A record of goods returned should be kept and checked to the credit notes received
from suppliers. 

 (d)      Purchase ledger and suppliers 
(i) A payables ledger control account should be maintained and regularly checked
against balances in the purchase ledger by an independent official. 
(ii) Payables ledger records should be kept by persons independent of the receiving of
goods, invoice authorization and payment routines. 
(iii) Statements from suppliers should be checked against the ledger account.

TESTS OF CONTROL
As already noted, tests of control should be drawn up so as to check that control procedures are being
applied and to achieve control objectives. One suggested way to design tests of control for a particular
situation is to list the documents in a transaction cycle and generate appropriate tests of control for each
document. We shall illustrate this approach here in connection with the purchases cycle (Note that a similar
technique could be applied to other transaction cycles!) 

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