Lesson 9: Formulating the substantive procedures for business

processes

Lesson 9.1: Revenue and receipts business process

Formulate substantive procedures

Refer to Auditing note chapter 10 under the heading

SUBSTANTIVE TESTING OF SALES.

Study

Note the following when studying the substantive procedures for

sales:

- They are formulated as an instruction

- The documents to be inspected are named
- The accounting records to be inspected are named
- Occurrence – the transaction recorded occurred and relates to the
client. This requires selecting entries and examining them against
all the relevant source documents.
- Accuracy – the transactions have been recorded at the correct
amounts (values). Therefore calculations (price x quantity) and
additions (cast) are important when examining accuracy.
- Cut – off – the transaction is accounted for in the correct financial
year (dates of transactions). By fiddling with cut-off dates
management can, for example, understate (to pay less tax) or
overstate (bonuses).
- Classification – the transactions have been posted to the correct
accounts. Again, you need to examine the source documents and
trace them to the sales journal and then to the general ledger
accounts.
- Completeness – nothing has been left out. Have all the invoices and
dispatch notes been recorded?
- Presentation – the transactions and events are appropriately
aggregated or disaggregated and clearly described, and related
disclosures are relevant, understandable and in terms of the
applicable financial reporting framework.
- Analytical review procedures – by comparing monthly and yearly
trends and ratios you can highlight errors.
Trade receivables (balances at year end)

Remember, when we verify balances at year end we do not go back and

vouch the transactions, because we have already done when we audited
the revenue and receipts. That is why the assertions for balances are
different to the assertions for transactions:

- Existence – the balances existed at year end – therefore the

procedure will start with trade receivables balance
- Rights – the company has the right to the amount owed by a debtor
- Completeness – all the debtors were included at year end and the
related disclosures that should have been included in the AFS, have
been included
- Accuracy, valuation and allocation – the balances are stated at the
correct value (not over – not understated) and any valuation and
allocation adjustments have been appropriately recorded, and
related disclosures have been appropriately measured and
described
- Classification – debtors are recorded in the proper accounts (general
ledger)
- Presentation – debtors are appropriately aggregated, and clearly
described, and related disclosures are relevant and understandable
in the context of the requirements of the applicable financial
reporting framework

Possible risks in the revenue and receipts business process

Revenue (per functional area)

- Customer order
- Warehouse/dispatch
o Warehouse risks
 Valid picking slips may not be acted upon
 Goods may be picked from inventory for
fictitious/unauthorised sales
 Incorrect items and quantities may be picked
 Inaccurate and incomplete delivery notes may be made
out
 “Out of stock” items may not be identified on the
picking slip
  Customer not notified of “Out of stock” items resulting
in loss of the sale and the customer goodwill
o Dispatch risks
 Theft
 Despatch errors (incorrect quantity of goods and/or
delivered to incorrect customer)
 Customers can deny receipt of goods
 Goods released from warehouse are not dispatched
- Invoicing
o Invoicing risks
 Goods dispatched may not be invoiced
 Invoices may be inaccurately prepared/misstated
(prices/quantities/descriptions, discounts, VAT)
- Recording of sales

Receipts

- Receipt of cash
o Receipt risks
 Amounts received may not be banked due to
carelessness or theft
- Recording of receipts
o Recording of receipt risks
 Deposits may never be recorded/not recorded timeously
 Recorded deposits may be inaccurate (errors),
overstated (fictitious deposits) or credited to the wrong
debtor
- Goods returned
o Goods returned by customer risks
 Description and quantity of goods returned may be
incorrect (therefore incorrect credit note)
 Credit note may be passed for goods not returned
 Credit notes may be incorrectly recorded to the incorrect
debtor
- Credit management
o Credit management risks
 Debtors may not pay at all or pay late
 Debtors are prematurely or inappropriately written off
 Debtors are written off without authorisation
For every functional area in a business process, you are expected
to understand the following at this point:

- The risks of material misstatement

- The relevant assertion related to the risk of material misstatement
- The controls that should be implemented to address these risks and
assertions
- How to assess this risk as high, medium or low
- Designing appropriate substantive audit procedure to address the
above

Lesson 9.2: Acquisition and payments business process

Refer to auditing notes chapter 11 under the heading ACQUISITIONS AND

PAYMENTS CYCLE AT PRORIDE (PTY) LTD.

Example

Buying more than is needed (overstocking) or paying excessive prices for

acquisitions.

Your primary task is to provide the shareholders with assurance that the
AFS is a fair representation of their business.

Therefore, designing substantive procedures to target risks and examining

the assertions makes good sense – but the auditor will not always know
where all the risks are hidden until some testing is done. The auditor has
to consider risks at financial statement level, at account balance level,
and at transaction level and then design the audit procedures to target
those risks to be able to express an opinion of the AFS in spite of the risks.
The AFS are a collection of managements assertions.

Activity 9.2.1:
Describe the risks for acquisitions (purchases) transactions, payment
transactions and trade payables and their related disclosures. Like these
risks to their related assertions.

Risks Assertion
Oder formed misused/unauthorised, e.g., for private Occurrence
purchases
Acceptance of short deliveries as full deliveries, Accuracy/
broken items, incorrect items occurrence
Goods received not made out at all Completeness
Goods received not made out accurately Accuracy
Collusion with supplier delivery personnel, e.g., theft Accuracy/
occurrence
Recording of incorrect amounts from incorrect Accuracy
invoices
Raising of fictitious purchases for which goods are Occurrence
never ordered
Delays, misallocation and posting errors resulting in Accuracy
reconciliation problems
Payment to fictitious creditors Occurrence
Payment of incorrect amounts Accuracy
Unauthorised payments Occurrence
Use of incorrect foreign exchange rates (foreign Accuracy
transactions)

Purchases and payments (transactions)

Refer to auditing note chapter 11 under the heading SUBSTANTIVE

TESTING OF TRANSACTIONS IN THIS CYCLE.

Activity 9.2.2

Risk Assertion Substantive procedure

Order forms Occurrence Inspect supporting
misused/unauthorised, documents are:
e.g., for private - Signed by
purchases designated
authority e.g.,
chief buyer
- Goods purchased
 are of a type used
by the company
Acceptance of short Occurrence/ Inspect delivery note
deliveries as full accuracy and cross reference to
deliveries, broken items, purchase order (PO) to
incorrect items ensure quantities agree
Goods received note not Completeness For approved purchase
made out at all orders, test a sequence
of POs and trace them
to GRNs. Investigate all
Pos that have no
corresponding GRNs
Goods received note not Accuracy Compare GRNs to
made out accurately supplier delivery notes
and purchase orders to
ensure quantities agree
Collusion with supplier Accuracy/ Cross reference all
delivery personnel e.g., occurrence supporting documents
theft (PO, DN, GRN) to ensure
proper authority of
purchase as well as
receipt of the correct
goods
Recording of incorrect Accuracy Reperform costs and
amounts from incorrect calculations on invoices
invoices Agree quantity per the
invoice to GRN

Recalculate VAT and

confirm discounts are
taken into account prior
to calculation of VAT
Raising of fictitious Occurrence For a sample of recorded
purchases for which invoices reference to
goods are never ordered supporting documents
(purchase order,
supplier delivery notes
and goods received
note)
Delays, misallocation and Accuracy Confirm mathematical
posting errors resulting in accuracy of invoice by
reconciliation problems recalculating all
extensions, casts and
discounts
Payment to fictitious Occurrence Inspect supporting
creditors documents and ensure
that all documents are
made to ExWHy (Pty)
Ltd and are from an
 approved supplier
Payment of incorrect Accuracy Agree amount per the
amounts invoice to the payment
in the cash journal
Unauthorised payments Occurrence Inspect authority of
payment, e.g.,
- Approved PO, GRN
- Approved
expenditure
requisition
- Approved
payment
requisition
Use of incorrect foreign Accuracy For a sample of foreign
exchange rate (foreign transactions agree the
transactions) rate used to spot rate
obtained from reputable
financial services
institutions

Trade payables (balance at year end)

Remember, when we verify balances at year end we do not go back and

vouch the transaction balances we do this when we audit the acquisitions
and payments. That is why the assertions for balances are different to the
assertions for transactions

- Existence – the balance existed at year end

- Obligation – their company has an obligation to pay the amount
sowing to its creditors
- Completeness – all the creditors are included at year end and all the
related disclosures that should have been included in the financial
statements have been included
- Accuracy, valuation and allocation – the balances are stated at the
correct carrying value (not over – nor understated) and any
valuation and allocation adjustments have been appropriately
recorded, and related disclosures have been appropriately measured
and described
- Classification – creditors are recorded in the proper accounts (i.e.,
general ledger)
- Presentation – debtors are appropriately aggregated, and clearly
described, and related disclosures are relevant and understandable
 in the context of the requirements of the applicable financial
reporting framework.

Study

Refer to auditing notes chapter 11 under the heading SUBSTANTIVE

PROCEDURES ON THE TRADE AND OTHER PAYABLES BALANCE

Activity 9.2.3

You are the audit manager and the audit partner has allocated you to the
client ExWhy (Pty) Ltd. You want to formulate the substantive procedures
to audit the trade payables balance of R18 152 112

Required:

Formulate all the substantive procedures necessary to audit trade

payables at year end.

Assertion: Obligation (Does the company have a duty to settle the trade
payables balance at year end?)

- For the year end trade payables balance inspect supporting

documents (invoices, supplier statements) to confirm:
o They are in the name of the company
o In respect of goods and services used by the company
Assertion: Existence (Do trade payables actually exist at year end?)

- Test that trade payables have not been overstated or recorded pre
maturely by:
o Inspect the purchases recorded close to year end correspond
to GRNs dated before year end

Assertion: Accuracy, valuation and allocation (Are the trade payables

valued at the correct amount?)

- Agree the list of creditors balances to the balance per the creditors
control account
- Agree the balance per the creditors control to the annual financial
statements
- Cast and cross cast the creditors list and creditors control account
- Enquire with management regarding any debit balances on the
creditors list and consider whether any should be transferred to the
debtors ledger
- For a sample of creditors included in the year end trade payables
account obtain creditors reconciliation and perform the following:
o Cast the reconciliation for mathematical accuracy
o Agree balances per the reconciliation to creditors statement
o Agree amount per the reconciliation to supporting
documentation

Assertion: Completeness (Has the company recorded all existing trade

payables at years end?)

- Compare the list of creditors at current year end to the previous

year end
o Identify creditors from prior year who do not exist in current
year or have reduced significantly in value
o Inspect supporting documents to corroborate reasons for
movement
- Inspect creditors correspondence file for any amounts requiring
adjustments as result of disputes with creditors. This may result in
the client not raising liabilities for such disputes.
- Inspect a list of GRNs not matched to invoices at year end and
o Inspect that a journal entry has been passed to raise the
corresponding liability
 o Recalculate eht amount by agreeing the price of the goods to
the purchase order or most recent pricelist
- Select purchases recorded in the month following year end
o Confirm that the GRNs do not relate to the current year end
- Select a sample of large payments made immediately after year end
(unrecorded liabilities)
o Confirm that payments relate to goods and services received
prior to year end by inspecting corresponding GRN and
delivery note
o Confirm that a corresponding liability was raised at year end

Assertion: Classification (have the trade payables been recorded in the

correct accounts?)

- Scrutinise the trade payables listing with reference to the existing

audit evidence
o Inspect that only amounts payable to trade creditors within
twelve months have been included
o Inspect that amounts that should not be included, e.g., short
term loans have not been included

Assertion: Presentation (are the trade payables disclosures in terms of

applicable IFRS?)

- Inspect notes to the annual financial statements and confirm:

o Disclosures are in terms of applicable IFRS
o Disclosures are consistent with audit evidence

Diagrammatic summary

Possible risks of the acquisition and payments business process

Acquisition (per functional area)

- Ordering of goods
o Ordering risks
 Ordering of incorrect goods
 Ordering of unauthorised goods
 Requisitions not acted upon timeously
 Inferior quality goods
 Paying high prices
  Order forms misused
- Receiving the goods
o Receiving of goods risks
 Acceptance of short, damaged, not ordered items
 Goods received note not made out accurately
 No goods received not made out
 Theft by employees or outside parties
- Receiving of invoice
o Receiving risks
 Recording of incorrect amounts
 Raising of fictitious purchases
 Delays and posting errors
- Recording of purchases

Payments (per functional area)

- Payment preparation
o Payment preparation risks
 Payment to fictitious creditors
 Payment of incorrect amounts
 Unauthorised payments
 Discounts lost due to late payment
- Actual payment
o Actual payment risks
 Payees made out incorrectly
 Invalid payments
- Recording of payment
o Recording of payment risks
 Payment may be recorded incorrectly
 Payment may be misstated to hide fraud
Lesson 9.2: Inventory and production business process

Study

Study auditing notes chapter 12 Auditing the cycle but excluding para 5.1
as it relates to tests of controls.

Note the following in the study source:

- Attendance of the inventory count by the auditor includes both

substantive procedures and tests of controls
- Financial statement assertions in the inventory and production
business process (remember, the assertions are also described in
ISA 315, para A190)
 - Make sure you know the difference between a test of control and a
substantive procedure. The definitions are described in ISA 330,
para 04.
- Substantive procedures are performed through inspecting,
observing, external confirmation, recalculating, re-performing,
analytical procedures, inquiring or by means of CAATs

Self reflection activity 9.3.1:

Solution

Accuracy, valuation and allocation

- Use CAATs to calculate the opening balance of this year by using the
applicable fields in this years master file and comparing this balance
with the closing balance of the prior year either by calculating the
closing balance using the same fields in the prior years master file
or with the closing balance in the financial statements. Follow up on
the differences
- Use CAATs to recalculate the value of the inventory at year end and
compare this value with the value in the general ledger and trial
balance
- Use CAATs to extract a sample of inventory item numbers for further
follow ups by comparing the purchase price in the master file with
the purchase price on the purchase invoices, taking into account IAS
2 where all costs directly attributable to the acquisition of inventory
should be taken into account (purchase price, import duties,
insurance on imports, transport, handling costs, etc)

Slow moving or obsolete stock

- Use CAATs to extract an exception report of inventory on hand at

year end that reflects zero year to date sales or no sales for more
than six month to identify slow moving or obsolete stock and follow
up with management
- Use CAATs to perform an analytical procedure to identify slow
moving or obsolete stock by comparing this years purchases with
this years sales in the months where the movement of purchases do
 not correlate to a similar movement in sales, perform a detailed
analysis thereof
- Use CAATs to scan the inventory master file for “error” conditions
and follow up exceptions with management. For example
o Average unit purchase price exceeds the unit selling price
o Zero in the quantity field but the date of the last purchase is
more recent than the date of the last sale
o Amounts in the value field but zero in the quantity field
o Negative purchase price or selling price or quantity
o Duplicate inventory item numbers

Accuracy, valuation – impairment

- Use CAATs to select a sample of inventory items from the master file
for further follow ups by tracing the selling price per item to the
most recent sales invoices
- Use CAATs to extract items still in inventory at year end that are sold
at selling prices below cost prices and discuss the need to write off
with management

Analytical procedures

- Compare the current year closing balance of inventory with the

inventory balance of the prior year and follow up on any significant
fluctuations with management.

Activity 9.3.2:

Required

Describe the manual substantive procedures that you will

perform to ensure that finished goods are accurate, correctly
valued and allocated at year end.

Inventory count sheets

 - Recalculate the value of individual items on the final inventory list
by multiplying the quantity with the unit price
- Cast the final inventory list
- Agree the total of the final inventory list (audited) to the balance of
the inventory control account in the general ledger and the trial
balance
- Perform standard analytical tests, including comparisons with
previous years figures and calculating the inventory turnover and
gross profit percentages. Obtain acceptable explanations for
deviations identified
- Perform an analytical procedure to identify slow moving stock by
comparing this years monthly purchases with this years monthly
sales and in the months where the movement of purchases does not
correlate to a similar movement in sales, perform a detailed analysis
thereof
- Compare the selling price on the approved price list with the cost
price on the inventory list to identify instances where the cost price
is higher than the selling price
- Determine through inquiries from management and the sales staff,
as well as by inspection of the minutes of correspondence files,
whether any of the inventory items are subject to special sales
conditions/offers
- Confirm the selling prices by inspecting a number of sales invoices
before year end with the selling prices on invoices after year end to
determine that the selling prices did not drop
- Where selling prices are lower than cost prices, request
management to make the required adjustments to net realisable
value (if material)
- Confirm through inspection of the previous years financial
statements that the accounting policy with regard to inventory is
applied consistently

Production records

- Obtain the production records and the formula for the finished goods
o Match the formula with that of the previous year for
consistency and obtain explanations for deviations
- Cast the formula costing records and agree the unit price of a trailer
to the cost price reflected on the finished goods inventory list
- Perform the following test on the formula costing records:
Raw material component:

- Compare the component codes and unit prices as reflected in the

formula costing records with the codes and unit prices reflected in
the raw material inventory list to ensure that they are the same
- Trace unit price to the relevant suppliers invoices to establish
whether the correct prices have been used in terms of the FIFO cost
formula

Labour component

- Confirm the allocated labour costs with the approved wages

information received from the wages department
- Agree the hourly rate in the formula costing records with the hourly
wage rate in the wage records and actually paid

Overheads

- Confirm the allocated manufacturing overheads with the approved

allocation basis and the use of accurate information pertaining to
normal operating capacity
- Evaluate the manufacturing overheads allocation basis, including
the periodic changes to this basis, for reasonableness and discuss
with the financial manager if required
- Inspect the inventory count sheets and the inventory records for
possible obsolete inventory. Discuss with management the
possibility of a provision for obsolete inventory
- Obtain a written representation with regard to the inventory value
as at year end.

Diagrammatic summary of the inventory and production business

process
Schematic representation on the audit of inventory and under
which business processes this would fall

Lesson 9.4: Payroll and personnel business processes

Revision
The two main types of transactions are processed through the payroll and
personnel business process:

- Payment to employees for services rendered (salaries and wages)

- Accrual and payment of payroll-related liabilities (employee
deductions such as taxes, pension fund and medical aid)

The payroll and personnel business process include the following classes
of transactions and account balances

Study

Study the paragraphs in the section “Auditing the cycle” in auditing notes
chapter 13

Note the following:

Financial statement assertions in the payroll and personnel business

process (remember, the assertions are also described in ISA 315, para
A190). Make sure you know the difference between a test of control and a
substantive procedure. The definitions are described in ISA 330, para 04.
Remember, this lesson deals with substantive procedures only.
Substantive procedures are performed through inspection, observation,
external confirmation, recalculating, reperforming, analytical procedures,
enquiring or by means of CAATs.

Self reflection activity 9.4.1

Occurrence

- Use CAATs to select a sample of employees fro the employee

Masterfile of C4UY and follow up differences with management:
o Verify all information against the personnel files kept in the
human resources department, for example inspect employee
contracts, copies of identity documents, banking details and
taxation numbers
o Perform physical positive identification of the employees on a
surprise basis by inspecting the information on the staff card
o Inspect the returns made to outside entities, for example
SARS, to ensure that the employees in the sample are
included on the SARS return
o Enquire with management to whom the employee reports
whether the employee has been employed throughout the
year
- Use CAATs to extract and compare a list of employees from the
employee Masterfile of C4U for the prior year and for the current
year to identify additions or removals of employees and compare
the information with supporting documents in the personnel files
(employee contract/resignation letter, etc), or
- Use CAATs to extract a list of employees with information in the date
of employment/dismissal/resignation fields and compare the
information with the supporting documents in the personnel files
(employee contract etc.)
- Use CAATs to scan the employee Masterfile of C4U for “error”
confitions and print an exception report to discuss these cases with
management. For example:
o Duplicate identify numbers or bank account numbers or
employee numbers or tax numbers
o Where an employee has resigned or has been dismissed, but
still has a value in the net wages field after the date of
resignation or dismissal

Accuracy

- Use CAATs to recalculate net wages to confirm the accuracy of net

wages
- Use CAATs to compare the toal of the net wages in the master file
with the balance in the general ledger and trial balance
- Use CAATs to extract a sample of employees indicating the normal
or overtime hours worked and compare with the hours logged by the
biometric reader access system
 - Use CAATs to scan the employee master file for any job grade or
rate changes during the year and follow up differences with
management (there should be no changes because job grade and
rate changes are only reviewed annually)
- Use CAATs to compare the rate of job grades A, B and C with
applicable rates for normal hours and overtime hours in the master
file of C4U and print and exception report whenever the wrong rate
is used for a specific job grade. Follow up exceptions with
management.
- Use CAATs to extract a sample of employees reflecting the rate and
job grades and verify these details with details described in the
personnel file in the human resources department. Follow up any
differences. Use CAATs to extract a sample of employees indicating
their deductions and inspect whether all deductions are in
accordance with appropriate tables and rules by comparing these
with supporting documentation
- Use CAATs to extract a sample of employees indicating their
deductions and recalculate the deductions (PAYE, medical aid) to
conform that calculations are performed correctly. Follow up
differences with management
- Use CAATs to scan the employee master file of C4U for “error”
conditions and print an exception report to discuss these cases with
management. For example:
o Negative wages, hours worked, rates or deductions
o No amounts in the “net wages” field where an employee has
been employued
o Net wages greater than gross earnings
o Overtime hours worked exceeding 30 hours per month

Analytical procedures

- Perform analytical procedures by using CAATs to compare the

following:
o The total wage expense for the current year with the total
wage expense for the prior year. Follow up any differences
above or below the 12% increase with management
(accuracy/occurrence)
o Current year wage expense compared with the budget. Follow
up any differences with management (accuracy/occurrence)
o Compare the month to month wages and follow up on any
material differences (accuracy/occurrence)
 - By using CAATs and the field available in the Masterfile of C4U
perform analytical procedures by comparing the total of the net
wages value per month for each employee with the total net wages
year to date value for each employee. Follow up differences with
management (accuracy)
- Perform the following analytical procedures by using CAATs:
o Calculate the average wage per employee for each month by
dividing the total wages by the number of employees and
follow up on any material differences when comparing the
average per month against the different months (accuracy )
o Compare the number of employees of this year with the prior
year (accuracy/occurrence)

Diagrammatic summary of payroll and personnel business process

Lesson 9.5: Finance and investment business process

Functioning of the finance and investment business process

The finance and investment business process is different from other

business processes, because the financial and investment transactions
usually occur less frequently and the amounts are substantial. Therefore,
the focus of the auditor shifts to the authorisation and approval of the
transactions (budgets, powers in terms of the MOI, minutes of meetings,
etc)

The financial business process relates to funding (inflow) while the

investment business process relates to investment or capital expansion
(outflow). In this business process, remember to incorporate your
Companies Act Knowledge and accounting disclosure and presentation
requirements.

Study

Refer to auditing notes chapter 14 THE ACCOUNTING SYSTEM AND

CONTROL ACTIVITIES and also THE FINANCIAL AND INVESTMENT CYCLE AT
PRORIDE (PTY) LTD.

Example

Designing your substantive procedures to target risks and collecting

sufficient appropriate audit evidence to support the assertions makes
good sense – but the auditor will not always know where all the risks are
hidden until some testing has been performed. The auditor has to
consider risks at financial statement level, at account balance level and at
transaction level and then design the audit procedures to target those
risks, to be in a position to express an opinion of the AFS in spite of the
risks. Because the finance and investment process involve such huge
amounts, approval of such transactions by authorised persons is crucial.