What is Substantive Audit Approach?
There are various approaches that the auditors from the audit firms in Johor Bahru can apply to perform audit activities. Among them, there is an approach called the substantive audit approach. The auditors would use this approach to confirm the transactions and events in financial statements by covering a large volume of them.
The principle of such an approach is that when the auditors cover a large volume of financial events and transactions that possess high value in the financial statements, the risk of not uncovering material misstatements (Also see What is Audit Materiality?) is lower.
A company may use a substantive audit approach in both external and internal audit activities. Sometimes, this is also called a vouching approach, and this indicates that by using this approach, the auditors perform most of the audit works by verifying and vouching the documents they have selected.
Compared to the risk-based approach, which is the most popular nowadays, the substantive approach is rather traditional. Nevertheless, the auditors will still use the latter when internal control over financial reporting of a company is weak (Also see A Checklist for Ways to Assess Internal Controls).
When the auditors use the substantive audit approach, firstly, they will review the internal control system of their customer that is associated with the areas which are audited or the financial reporting system. They do this by recording all crucial control areas as well as the procedures.
Once they have understood the internal control, the auditors need to ratify the key control to make sure that every single key control area is functioning appropriately. When the auditors have finished validating the key control, then they will conclude whether the key control areas are dependable.
If they have high reliability, the risks (Also see Types of Audit Risks and Their Sources) that the internal control over financial reporting could not detect material misstatements are low. On the other hand, if the controls have low reliability, there is a high risk that the control is unable to identify the misstatements.
The substantive audit testing is much dependent on the conclusion that the auditor has made on internal control testing. If the auditors concluded that the controls are strong, they do not need to do much on the substantive testing, which indicates that they need to test and verify fewer samples (Also see Introduction to Audit Sampling).
Nevertheless, in some scenarios, auditors may not test the internal control of their customer (Also see What is a Test of Control?), since according to what they know, they can conclude that the customer’s internal control is not reliable. In such a situation, the auditors will not test the key controls, and they will conduct a substantive test straight away. As their customer does not have reliable control over financial reporting, they have to obtain a lot of samples, and this may reach 100% to reduce the risks of material misstatements.
Regardless of how strong the internal controls over financial reporting are, auditors should never rely totally on those controls and ignore the substantive tests. They still need to conduct a substantive review.
Ways to Perform a Substantive Audit Approach
As we have stated above, such an approach pays more attention to vouching. This indicates that when the auditors are performing an audit on the financial by utilising this approach, they will choose and verify most transactions and events of the items in the financial statements (Also see Types of Audit – Financial Statement Audit). Those items include revenue, expenses, assets, liabilities as well as equity. As an instance, when an auditor is conducting testing on the assets, he or she needs to test the essential event and the transaction of the assets.
That is to say, the auditor will select a large number of assets to inspect them physically when he or she needs to confirm the completeness and the existence of the lists of assets.