What is test of details of transactions?

Test of details is a substantive procedure.

It’s a response to the risk assessment.

Substantive procedures help Auditor to

• Obtain sufficient and appropriate audit evidence
• Confirm that the financial information is free from material misstatements. 

Test of details is testing the financial information by diving into the details of

• Transactions,
• Account balances, and
• Disclosures.

Here, we perform testing by verifying all the underlying supports. 

Reliability of supports varies depending on the nature of supports.

Chapter 1: How does Auditor deep dive into details?

The auditor validates these account balances, transactions, or disclosures with supports such as invoices, agreements, or company policy documents. In addition to this, Audit team can also perform inquiries to obtain more persuasive audit evidence.

How about an example?

Let us understand this concept with Debt testing. Debt is one of the significant business liabilities. Current year transactions for this account balance primarily include new borrowings and repayments done. Testing of these two debt components is done in the following manner:

New Borrowings

Verifying and confirming the New Borrowings with the Loan agreements is the first step. Further, audit team also verifies the receipt of the amount by tracing it to the bank statements.

Note: Lenders sanction loans subject to terms & conditions such as Interest rates, Collateral Security, Periodical submission of certain documents (Stock or book debts statement, Financials), etc. These terms & conditions are called as covenants. Audit team shall test those covenants especially if the loan is from related parties. This is because borrowers might charge exorbitant interest rates or impose unusual terms in case of related party transactions. Above all, audit team shall also Consider the nature of the transactions while performing testing procedures.

Repayments:  

Repayments are tested by verifying whether the payments are made per the debt repayment schedule of the debt agreements and confirming the payment amount from the bank statements. 

Agreeing on the payment with the debt schedule helps the audit team in understanding if there any payments made over and above the required amounts as per schedule. If it is the case, the audit team need to understand the reasons by performing inquiries with management and request further support.

Are you wondering why does the entity pays amount in excess of the stipulated installments?

These could be due to excess cash available or sourcing funds for a lower rate of interest. Therefore, its always advisable to perform inquiries for all the questions we have as audit team. (or)

The other reason could be Banks/FII’s demand excess repayment owing to unfavorable cash position which draws auditor attention to consider the concerns relating to going concern assumption.

Why does beginning balances and Closing balance not considered in the above example?

In case of recurring audits, audit team agrees the beginning balance to the previous year audited ending balance. If the audit is for first year engagements, then auditor need to obtain the break up of the opening balance and test those balances in the same manner as above.

Closing balance is the balancing figure. We have comfort over the beginning balance, borrowings and repayments with above mentioned procedure. Therefore, the balancing figure is nothing but the debt ending balance. We need not test it separately because we can arrive at the closing balance by recalculation.

Additional Procedures:

In addition to the above procedures,

• The Auditor verifies if the recording of the accounting entries is accurate and

• Checks the occurrence of a transaction as per the entity’s policies. 

How does verification of Entities Policies is done?

Transactions needs to go through as per the standard operating procedures set by the entity or management.  For example, Entities might have a standard approval policy for authorizing payments. Standard Approval policy stipulates that repayments more than $50M require approval of the CFO. Then the audit team confirms if this step is followed without any deviations. Testing of these steps forms part of Internal control audit.

Conclusion for Example:

 So, the Auditor verifies the authenticity of the transaction by looking into the details of the transaction. Here the supports used by the audit team (Loan Agreements and bank statements) are not in the control of the entity under audit. These are third-party statements/supports, and so the entity could not manipulate them. Therefore, the quality of audit evidence is high, and it enhances the Auditor’s comfort over the financial information under audit.

Also Read: TDS Journal entry relating to Salary

Chapter 2: How does the Test of details performed?

Auditors design these tests after considering the risk assessment results, underlying account balance tested, nature of risk, and previous year misstatements, if any. So, this substantive testing procedure gives more reasonable assurance

Here’s an example:

“Always Correct” professionals are the auditors of “Failure Associates.” The audit team has obtained the understanding of the entity and its industry and also by performed a preliminary risk assessment.

Further, all the Audit findings are below:

A) Understanding the entity and its industry

Failure Associates are into the business of manufacturing toothpaste. This Company is one of the major players in this industry. Toothpaste is one of the Rapid-growing segments of the Fast-Moving Consumer Goods industry.

Considering the economy in which this entity operates, the audit team believes that the business risk is lower due to the following:

• Unlike technology industry, the FMCG industry is not a rapidly changing sector. So, customer preferences will not change that quick.
• Entity has built a good reputation over the last two decades. Due to this Brand power, Company built trust and reputation among the consumers
• Company has agreements with the raw material suppliers and wholesale distributors for the next ten years. Therefore, there is no question on non-continuity of the business

Note: The above considerations are very subjective, and it depends on auditors’ understanding of the entity and its industry. However, this example is to help the readers to provide an overview of how things work at the audit team side. So, use these as examples to brainstorm further and consider all the business-related factors to determine the business risk.

B) Account Balance

We will try to understand this aspect with a GL Account – Sales.

The significant risks relatable to revenue are overstatement to build up a higher-profits and establish the Company as good performing. Thereby increasing the credibility in the eyes of financial institutions and will be able to grab more funds for lower interest rates.

Note: Revenue is a higher risk account balance in most of the industry in general

Considering these, Auditor decides to perform the Test of details. As the Auditor believes that risk is higher, the team decides to test 100% of revenue without following the sampling technique. Audit team follows the Confirmation techniques for performing the Test of details.

Confirmation: Confirmation is a process by which the audit team sends an electronic or physical copy of the information to the customers (in case of revenue confirms) and requests to respond whether the information therein agrees with their financial records. There are two different types of confirmation requests. The one explained above is a positive confirmation request. 

In Negative confirmation requests, the information that needs to be confirmed is not mentioned in the requests. Its a blank request form. Thus, the receiving entity has to provide all the information in the request form.

Therefore, there is less probability of response for negative confirmation requests.

So, the Audit team prefers sending Positive confirmation requests for all the revenue recorded in the books of accounts to the customers. Based on the response, if the balance as per requests agree to the revenue balance as per books then auditor completes the revenue balance testing. If its not the case then auditor will understand what is the amount of difference, reasons for the variance and investigates further depending on the nature of errors.

Chapter 3: What are the ways of performing Tests of details?

1. Vouching:

All the Entries accounted in the books of accounts are verified for accuracy and occurrence with the underlying supports. 

Example:

ABC Company records Repairs & Maintenance expenses amounting to $25,000 in May. The audit team obtains the bills/invoice relating to the expenses and checks the following:

-Whether the bills are in the name of the entity

– Confirms whether the date and year relates to the period under audit

– Verifies whether the nature of expense corresponds to the entity. If a software entity purchases a lubricant, then Auditor shall understand the need by performing inquiries and also shall use his understanding of the industry in this context

– Verify whether accounting entries are reflecting in proper accounts

– Check if the expenses are eligible for capitalization based on nature. Audit team can perform this check by obtaining the help of Industry expert who is well ware of those nature of expenses.

Auditors also performs the analytical procedures based on entity’s risk-assessment. This procedure gives an excellent boost to the Auditor’s comfort over the financial information. So, consider using analytics along with the Test of details.

In short, increasing the extent of procedures with analytics will result in more persuasive audit evidence.

2. Confirmations: 

Auditors obtain confirmation of the account balance from a third party. The entity could not alter the information reported by the third party. Here, Banks, Financial Institutions, and Debtors are examples of the third party confirmations .

Nowadays, the way Auditors sending confirmations changed. It moved into an electronic mode which is more reliable and quicker. This Covid-19 made it nearly impossible to do manual confirmations. So, a website called “Confirmation.com” helps auditors in sending confirmations to banks. The response time and turnaround depend on banks. Usually, it’s around two weeks. Auditors need to pay some fees (It Costs around $32 on an average basis for each confirmations) This price varies from bank to bank. So, check in the website. Billing details are available on the confirmation website itself.

Testing of Bank and Loan balances is possible with this confirmation website. This portal has arrangements with various banks and financial information. There are a lot of resources like guides or FAQs for each topic. These help the user (Auditor) to understand the process. Even they have chat/email/call service available to resolve user queries.

An audit is to give an opinion on the financial statements or information. In general, Auditor verifies the balance as of the period end. Accounts receivable and Accounts payable GLs can be tested by verifying the receipts or payments after the period end. Refer to AP article for understanding the subsequent payments testing procedure.

Note: Auditor might choose to test 100% of population or even adopt for sampling method. So, the nature and extent of misstatements are considered before deciding on which approach to follow.

How about an example?

Let’s say, “ASAP” Company has debtors’ balances of $568,000 as of year-end. Based on an understanding of the entity and industry, team believes that the credit period of 30 days is appropriate for the audit.

So, audit team needs to obtain the bank statements for the month after year-end. A detailed break up of debtors list as of period end is also requested from management.

All the debtor receipts are traced to bank statements.

Note: The period for which bank statements are required depends on the credit period.

Note: The percentage of testing generally depends on the risk factors. It’s a common practice to test 100% Population of Accounts Receivable and Revenue. However, other factors such as entity under audit, risk assessed, entity industry, etc., are considered before deciding whether to test 100% population or use a sampling technique.

Test of details might result in finding misstatements or errors. Read the article on Performance materiality to understand the different types of misstatements

4. Ancillary Procedures:

Ledgers Scrutiny is ancillary procedures that aids in performing the test of details. Audit team performs sampling procedures for performing this substantive procedures. High Level Scrutinizing of Ledgers or Transactions will help the audit team to identify the odd transactions or ledgers.

How about an example here?

Every Business wants to survive for a infinite longer period. There might be some incurred expenses being not eligible for tax purposes. The best example will be personal expenses of director recorded in the books of accounts under the head staff welfare GL Account. This expense is not allowed as deduction from the gross income. Such transactions or Ledgers needs to be identified by doing a key words search or filters.

Test of details Conclusion:

In Conclusion, the Test of details is a method of auditing financial information by digging deep into the details of transactions. To keep it simple, it is the process of obtaining comfort over the transactions by checking with the underlying supports. Vouching, Confirmations and Subsequent receipts are the way to perform Tests of details. The approach is subjective and depends on the professional judgment of the Auditor. Further, it also differs from account balance to account balance. So, one method will not be a good fit for testing of all the account balances. This is a key step in audit of financial information. Therefore, auditor shall use his professional judgement to select the appropriate method of testing.