ACT501 Chap.7 The Seven Audit Procedures and When Each One Works
The Seven Audit Procedures and When Each One Works
Two layers, and why merging them costs marks
Procedures sit on two layers. The first is purpose. Risk assessment procedures come first: they build a picture of the business, its setting and its controls so that the risk of material misstatement can be sized.
Then come further audit procedures, splitting into tests of controls, which establish whether controls actually work to stop material error or to catch it and put it right, and substantive procedures, aimed at finding material error attached to a particular claim.
Substantive work splits once more into tests of details, which hunt for error or fraud inside a class of transactions, a balance or a disclosure, and substantive analytical work, which judges reported figures by examining the relationships you would expect between financial data and the operating facts behind it.
The second layer is the specific act performed, and any of those acts may serve any of the purposes depending on the context.
The seven acts
Inspection of records and documents, in any medium, prepared internally or externally.
Inspection of tangible assets such as property, plant, inventory and securities certificates, which gives compelling evidence of existence and tentative evidence of valuation through condition, but does not establish ownership. Watching somebody else carry out a process in front of you. Inquiry of knowledgeable people inside or outside the entity.
External confirmation, meaning a written reply sent straight to the auditor by an outside party. Recalculation, meaning redoing the arithmetic in a document or a record. Reperformance, meaning the auditor carrying out for herself a control the entity has already run, commonly used while completing a walkthrough.
And analytical procedures.
Two acts come with explicit limits
Watching tells you only about the moment at which it happens, and being watched may itself change how the work is done.
Asking can run through the whole engagement beside other work, and it ranges from a formal written request to a conversation in a corridor, but putting a question to the entity's own people never amounts on its own to enough evidence for a conclusion, so every answer has to be backed by independent findings.
Direction decides which error you could find
Inspection of records has two named methods that are the same act performed in opposite directions along one chain of documents.
Vouching starts from something already sitting in the books, generally a journal or ledger entry, and walks it backwards to the paperwork that started it, testing existence or occurrence. Tracing starts from an original document and walks it forwards into a journal, a ledger and ultimately the published accounts, testing completeness.
Choosing the direction is choosing the population, and choosing the population decides which misstatements could ever be drawn into the sample.
Confirmation is a process, not a letter
Confirmations are frequently relevant to assertions about balances: banks for cash and loan balances reaching existence and accuracy; customers for receivables, again existence and accuracy; agents holding inventory on consignment or in warehouses, reaching rights and obligations; suppliers for payables, reaching completeness.
Three process rules attach. The request normally goes out on the entity's own headed paper, signed by one of its officers, because the counterparty needs that permission before replying. The audit firm must control the process so it is not open to alteration by the client.
And responses must be returned directly to the firm.
Analytical procedures, and their three timing points
These compare recorded amounts, or ratios built from them, against expectations the auditor develops from relevant financial and non-financial data.
Five general forms are given: comparison against comparable prior periods; against the entity's budgets and forecasts; judging this year's balances against the patterns the entity's own history makes predictable, such as how stock levels move with the cost of what was sold; comparison with industry statistics; and study of relationships with non-financial information such as physical production statistics or unfilled orders.
They are required at planning as risk assessment procedures, optional during substantive testing where they can be less costly and more effective than tests of details, and required again near the end of the audit to form an overall conclusion and to ask whether a risk of material misstatement went unrecognised.
A ranking with a warning attached
Inspection of an asset, reperformance and recalculation sit high; confirmation, inspection of records and documents and analytical procedures sit in the middle; observation and inquiry sit low.
The hierarchy is general and depends on the facts and circumstances: a confirmation sent to an independent third party genuinely qualified to answer can be highly reliable. The operative rule is that as audit risk rises, the chosen procedures must be more searching and more dependable.
What this chapter covers
- 01
Purpose layer: risk assessment, tests of controls, substantive procedures
- 02
Tests of details against substantive analytical procedures
- 03
The seven specific acts, and what each one can establish
- 04
Why inquiry alone is never sufficient evidence
- 05
The two limits on observation
- 06
Vouching against tracing, and the population each one samples
- 07
Confirmation and its three process rules
- 08
Five forms of analytical procedure and their sources of expectation
- 09
Required, optional, required: the three timing points
- 10
The general reliability hierarchy and the caveat attached to it
Four objectives, four drafted procedures, two that cannot work
- 3Name the population each drafted procedure samples from.
- 4Say which objective that population cannot reach, and why.
- 3Rewrite the two failing procedures.
Key terms
- Tests of Controls
- Work designed to establish whether controls actually stop material error attached to a claim, or catch it and put it right.
- Substantive Procedures
- Work aimed at finding material error attached to a claim, made up of tests of details and substantive analytical work.
- Vouching
- Starting from something already booked and walking it backwards through each processing step to the paperwork that started it, which tests existence or occurrence.
- Tracing
- Starting from an original document and walking it forwards through processing into the journals, the ledgers and the published accounts, which tests completeness.
- External Confirmation
- A written reply, on paper or electronically, sent straight to the auditor by an outside party.
- Reperformance
- The auditor carrying out for herself a control or procedure the entity's own staff have already run.
- Analytical Procedures
- Comparisons of reported figures, or ratios built from them, against expectations the auditor forms from financial data and the operating facts behind it.
- Walkthrough
- Taking a single transaction through every stage of processing, to confirm that the system described is the system that exists and to find the points where controls bite.
The Seven Audit Procedures and When Each One Works FAQ
When are analytical procedures compulsory?
At two of the three points where they can be used. They are required at the planning stage, performed as risk assessment procedures to deepen the understanding of the business and point at areas carrying specific risks, and they are required again near the end of the audit to form an overall conclusion on the statements and to ask whether a risk of material misstatement went unrecognised.
In between, during substantive testing, they are optional, because analytical work is only one route to comfort over a caption and the auditor may prefer tests of details.
Why is inquiry treated as a weak procedure when auditors ask questions constantly?
Because putting a question to the entity's own people never amounts on its own to enough evidence for a conclusion, which is not the same as saying it is worthless. Asking is fast, it can run beside every other kind of work, and it points attention better than anything else available.
What it cannot do is close a point on its own, so every response has to be corroborated by independent findings from other procedures, and a file whose conclusions rest on recorded conversations is a file with a structural problem.
What makes a confirmation valid?
Control of the process rather than the wording of the letter. The request normally goes out on the entity's own headed paper, signed by one of its officers, because the counterparty needs that permission before replying; from that point the audit firm must keep hold of the process so the entity cannot interfere with it, and every reply must come back straight to the firm.
A reply handed over by the client has become external-internal evidence and no longer carries the weight a confirmation is chosen for.
Does inspecting inventory prove the company owns it?
No, and this is the standard trap. Physical inspection provides compelling evidence of existence and tentative evidence of valuation, because damage and obsolescence are visible. It provides no evidence of rights and obligations, since goods held on consignment for another company look exactly like goods the entity owns.
Only the contract settles ownership, which is why a count is always paired with enquiry about consignment and with confirmation from third parties holding stock.
Exam move
Write the seven acts down the side of a page and the four objectives existence, completeness, valuation and rights across the top, then fill the grid with a tick, a cross or a qualified note. The empty cells are the examinable ones: they are where a procedure that sounds sensible cannot reach the assertion, and being able to say why in one clause is what separates a designed procedure from a remembered one.
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