Substantive Procedure

Substantive procedures are the method or audit tests designed by an auditor to evaluate the financial statements of the company, which require an auditor to create conclusive evidence for verifying the completeness, accuracy, existence, occurrence, measurement, and valuation (audit assertions) of the financial records of the business.

• Substantive procedures are audit procedures performed by the auditor to obtain adequate audit evidence to support the auditor's opinion on the financial statements.
• It is used to calculate the company's financial statements and to analyze the completeness, accuracy, existence, occurrence, measurement, and valuation of the business's financial records.
• Test of details and substantive analytical procedures are the two types of substantive procedures.
• Substantive audit procedures are used to collect evidence about the business transaction and its occurrence and validity and verify its existence. In addition, the accounting treatment genuineness can also be tested.

The intention behind performing the Substantive procedures by an auditor is to check that there is no material misstatement in the business's financial records, i.e., they are complete, accurate, valid, and all the material information is disclosed. The method followed includes testing the account balances, examining the general entry, and other adjustments made while preparing the company's financial statement. It also includes making inquiries about suspicious transactions. Some examples can be external party confirmation like confirming the company's bank balance from the Bank directly, performing a physical inventory count, confirming accounts payable from creditors of the business, etc.

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For example, there is a company named BSR Trading, whose financial statements of the company show the following balances:

1. Cash balance of $2,500
2. The bank balance of $6,000
3. Accounts receivable balance of $10,000
4. Trade payable balance of $8,000
5. Inventory of $5,000

Now the substantive procedures that can be followed on the above balances are:

1. The physical verification of the cash balance is to be done to check that the balance is accurate.
2. To verify a bank balance of $6,000, the auditor shall send written mail to the bank of the client to confirm that the client's balance in the books of a bank is the same as that in the account books of the client. If there are any discrepancies, the bank reconciliation statement is to be prepared. If any differences still exist, the auditor should inquire to find out the difference.
3. For account receivable balances, the sales invoices should be verified, and also the debtors can be asked to confirm their balances.
4. For Trade Payable balances, the purchase invoices should be verified, and also the Creditors can be asked to confirm their balances.
5. To check the balances of inventory purchases, invoices, and sales invoices, should be verified, and the physical counting of inventory should be done.

There are two types which are as follows:

#1 - Test of Details

Test of details refers to collecting evidence that helps evaluate the correctness of the account balances, disclosures, and other accounting transactions made by the business entity in their financial statements.

#2 - Substantive Analytical Procedures

Analytical procedures are an important method performed while conducting the process of auditing. In the analytical procedures, the evaluations are made on the financial statements by studying the plausible relationships between financial and non-financial data. For example, computation of ratios, comparing past year balances with the current year, etc.

It followed to check the purchases of the raw material of the business:

1. Firstly, the purchase orders and the respective invoices should be verified, and then the invoices are to be matched with the GRN (goods receipt notes) to check that the respective goods have been received for every purchase invoice.
2. Rates and the quantity purchased in the purchase order should be the same as the purchase invoice.
3. Then the posting of items received in the relevant ledger accounts should be verified.
4. Then the cut-off procedures on the purchases should be performed.
5. Last but not least, the analytical procedure is to be performed by comparing the purchase trends of last year with the current purchases, and if there is a major difference in the trend, then the reasons for such difference should be found.

The substantive procedure followed to check the Related party transaction of the business:

1. The transactions with the related parties are important. These transactions have more chances of inaccuracy because they are with the parties that are related to the owners/ directors of the company.
2. The auditors should obtain the relevant evidence to check these transactions' nature, purpose, and extent. Also, it should be evaluated that these transactions are at an arm's-length price.

The substantive procedure is important to check the accuracy & completeness of a business transaction, measurement & valuation of an asset or liability of that business, and check that all material items are disclosed properly, etc. These procedures are important while conducting the audit to comment upon the truth and fairness of the company's financial statements. It assures the following assertions to the auditor:

1. The existence of assets and liability on the given date.
2. The assets reported must be owned by the company on the given date.
3. The liabilities reported must be the company’s obligations to pay on the given date.
4. All the assets and liabilities that existed should be appropriately valued and recorded in the company's financial statements.
5. Events or recorded transactions must be related to that auditing period only.
6. The transaction is recorded at the correct amount, and only those expenses and revenues are recorded that pertain to that period.

Substantive audit procedures are tests designed to collect evidence about the business transaction. The occurrences, validity, and existence of the transaction can be verified, and the accuracy of their accounting treatment can be checked.

This has been a guide to what is a substantive audit procedure. Here we discuss examples of such audit tests on accounting transactions and their types. You may learn more about finance from the following articles –

• Audit Test
• Purpose of An Audit
• Financial Audit
• Social Audit